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Q184 Chairman: Good
morning and welcome to everybody on this inquiry into the Defence Industrial
Strategy, particularly John Chisholm from QinetiQ. Sir John, perhaps I could begin by thanking you for coming to
give evidence about the Defence Industrial Strategy. I wonder if I could open up our inquiry this morning by thanking
you particularly for your memorandum on the Defence Industrial Strategy and
read out a couple of bits of that. It
says in your memorandum, "The Committee should consider this apparent internal
contradiction in a document that speaks so strongly to the importance of
technology and innovation on almost every page, yet is silent on the level of
defence research funding." I am not
trying to put words in your mouth, but I think you are pleased with the
recognition of the importance of research and all that that implies within the
Defence Industrial Strategy. Do I
detect a degree of disappointment with what is actually said about it in the
White Paper?

Sir John Chisholm: Good morning, Chairman. Yes, I think you have seized the substance
of our evidence. The first point is
that we are pleased with the overall thrust of the Defence Industrial Strategy. I think Lord Drayson has done an excellent
job in a short period of time to grab a hold of the whole issue of procurement
in the United Kingdom and to devise the main themes of a strategy as to how to
improve procurement and also improve the industrial base which underpins
procurement. We have counted that there are some 600 mentions in the DIS to the
words "research, technology and innovation" and that underpins what you have
already said, that clearly research and technology appear to us to be well
represented as key to a Defence Industrial Strategy. Having said that, there is not a carry through in this version of
the DIS as to what the consequences might be in terms of the provision for
research and technology in the future.

Q185 Chairman: What do you think it should have said about
that?

Sir John Chisholm: We would argue that the logic of the DIS is
that research and technology expenditure should be increased to something
closer to what it used to be. The paper
says that research and technology is important in creating the quality of
equipment that the Armed Forces eventually buy; that is clearly implied in the
work that underpins the DIS. If that is
the case, the equipment that we are buying today reflects the amount that was
put in to research and technology in years gone by. If the amount that is now being spent on research and technology
is less than what was spent 15 years ago then the implication is that
eventually we will suffer from a lower quality of defence equipment than we
currently buy. If we actually want the
same quality of equipment as we now have then the logical conclusion would be
that we should increase the amount currently being spent on research and
technology.

Q186 Chairman: On page 39 it says, "A recent MoD sponsored
study analysing 11 major defence capable nations has uncovered a highly
significant correlation between equipment capability and R&T investment in
the last five to 30 years."

Sir John Chisholm: Indeed so.

Q187 Chairman: So more should have been said, you would
suggest, in the Defence Industrial Strategy about the way that that R&T was
going to be encouraged.

Sir John Chisholm: I do not think I am able to say that more
should have been said. I would say that
more can be said on that subject.

Q188 Chairman: On page 142 of the Defence Industrial
Strategy the words appear "specifically, we will review the alignment of our
research programme with MoD needs, conduct further work better to understand
the underpinning technologies, update our defence technology strategy, develop
a better understanding of the innovation process ..." In other words, there is a lot of work still to be done.

Sir John Chisholm: That is how I understand it. As I understand it, this paper says that
this is an area which is incomplete in the DIS and more work is now going to be
done in order to fill out that gap.

Q189 Chairman: The way you put it suggests that QinetiQ is
not involved in this work or has not been asked to be involved in this
work. Is that right?

Sir John Chisholm: The work that needs to be done is obviously government
work and QinetiQ, as the other contractors, will eagerly participate in any way
they can in helping the government proceed with its strategy.

Q190 Chairman: Have you been asked to be involved in that
work yet?

Sir John Chisholm: There is every indication that we will be
involved in that work, yes.

Q191 Chairman: What do you think you would be likely to do
in relation to that work? What would
you like to do in relation to that work?

Sir John Chisholm: We can certainly assist, as we have been
doing in the past, in helping the Ministry of Defence decide what the areas of
significant priority are. It is,
however, for the Ministry of Defence to decide exactly how much money it is
appropriate to spend on research and technology. The evidence that we can provide would say that the increased
expenditure in research and technology will lead to the quality of equipment
which the Armed Forces require in future years.

Q192 Mr Crausby: You argue that there is a strong case for
increasing funding for defence research and that was effectively the line that
Mr Ferrero took on 7 February when he said, "As I look at the labs today I see
a constant reduction in government investment in these technologies and,
ultimately, a reduction in the level of innovation that is coming out of the
labs." In your memorandum you say that
the Defence Industrial Strategy fails to address the implications of the decade
long decline in research funding. What
are the implications, and what is likely to be the long-term consequences of
this obvious reduction in UK defence research investment?

Sir John Chisholm: The obvious consequence of a decline in
research expenditure is less resources being available in the labs. Eventually they fall below a critical level
and you simply have to stop doing that research. In recent years what we have seen is that the remaining funding
has gone as a proportion more to shorter-term research which supports more
urgent needs and therefore the larger cutbacks tend to fall upon the longer
term, more generic research which is the area from which many of the more
profound developments in technology eventually emerge.

Q193 Mr Crausby: I know it is difficult to predict the future
without doing the research. Have you
got any concrete examples as to how you see that that will put us behind?

Sir John Chisholm: The area which generates new sensor systems,
for instance, is an area of technology which in the past has produced important
innovations, such as thermal imaging.
That is an area where there has been a consistent cutback in the
research funds. The consequence of that
is one has less resources to investigate very promising future
developments. If you do not investigate
those you then do not get the breakthroughs and you do not get the equipments
which eventually come from that.

Q194 Robert Key: I am very concerned about this level of
research spending. As you point out in
your memorandum to the Committee, in the Defence Industrial Strategy the government
talks about the real terms decline but it does not make any mention of how much
defence expenditure should rise by. You
assume it will be a drop in real terms though an increase in cash spending but
the government does not even say that.
Were you very surprised it said nothing about the level of research
spending?

Sir John Chisholm: We would certainly argue for an increase in
research spending if the objective is at least to ensure the same quality of
equipment as we are getting right now in the Armed Forces.

Q195 Robert Key: What do you think is the main driver of
research spending by universities? Is
it blue skies research, their reputation internationally or are they waiting
for signals from government in particular areas that the government would like
to see research done in?

Sir John Chisholm: If your question is what is driving
university research spending, that is driven largely by the research councils
and their process. Their process is
heavily driven by the academic quality of research. The research assessment exercise in universities is what drives
it. That is driven by citation indices
in publication in journals. That is an
entirely different mechanism to the mechanism which we are talking about here
where the objective of defence research expenditure is superior equipment in
the hands of soldiers, sailors and airmen.

Q196 Robert Key: Do you consider yourselves to be in competition
with that university-based research?

Sir John Chisholm: Certainly not. It is our role to draw upon the university-based research and
make it useful to soldiers, sailors and airmen.

Q197 Robert Key: Is it getting more difficult to recruit and retain
the sort of researchers you want?

Sir John Chisholm: It is always difficult to recruit and retain
researchers if you do not have the funding to support them. Our business is to win research contracts
and conduct them for the Ministry of Defence primarily. If the money is not there for those research
contracts we cannot obviously employ the staff.

Q198 Robert Key: Have you given thought to how much money the
government should be spending on defence research?

Sir John Chisholm: We have done a calculation and it runs along
the lines that if defence expenditure has reduced by 50 per cent in real terms
over this period of time and it was that defence expenditure which gave us the
equipment today which we feel satisfied with, you might argue that you need to
increase defence expenditure back to where it was. We could mitigate that a little by saying that surely we are more
efficient now than we were 15 years ago, but an increase of the order of 25 per
cent is what we believe would be a sensible policy decision.

Q199 Chairman: Is that an increase of 25 per cent in
relation to defence as a whole or in relation to research, technology and
innovation?

Sir John Chisholm: Research.

Q200 Mr Havard: What you seem to be saying to me is that
within the Defence Industrial Strategy there is going to be another strategy
looking at research and technology.
That work seems to be not very far forward yet. Do you see that then driving your number or are
you going to go in with this bid of increasing by 25 per cent as part of your
strategy negotiations for research and technology? It seems to me scientists always argue that the research is
better depending on how much money they get.
I am not sure that is always true.
I understand there is a need for research and technology to be properly
funded. Which way round is that going
to work? Is it the case that you will
go in with a handful of cards saying we want an increase of 25 per cent when
the reality of the situation is that what should really happen is that that
research and technology sub-strategy within the Defence Industrial Strategy
should drive the real decision about what is required? Is that the desire that you think is coming
from the Ministry?

Sir John Chisholm: I would certainly accept that the level of
research expenditure should be driven by the strategy. So the work that you referred to, which is
referred to in the DIS, on the analysis of a research and technology sub-sector,
the output of that, I would argue, would appropriately be an increase in
research expenditure.

Q201 Mr Hancock: I would be interested if you could explain to
the Committee what you think your company's role is in the future bearing in
mind what you have said and the past history of the organisation and where it
is today.

Sir John Chisholm: The core business of QinetiQ remains the
business of technology and innovation in the UK and in the area of defence and
security. So we have three main
businesses: one is defence and security technology for the UK; secondly, the
commercialisation of those technologies into adjacent commercial markets,
principally in the UK, and, thirdly, the development of our business in the US
based upon those same technologies.

Q202 Mr Hancock: Do you not think you have some responsibility
now to invest in the research and development and then sell what you have
discovered to the MoD? Smart
procurement really demands that the MoD does not pay as much on research and
development. Surely it demands that
organisations like you have to take the risk on the research and development in
the hope that you can then sell a much better product to the Armed Forces for
the use of the personnel involved.

Sir John Chisholm: Research the world over has the
characteristic that that which is near to market can be invested in by
companies and that is the sensible decision for companies to make. Following on from market research, it is
much more difficult to see who will get the particular benefit of that research
and therefore throughout the world, far from market research as funded by governments,
because it is only governments who can take the rational view that benefit will
accrue somewhere ---

Q203 Mr Hancock: But this policy states they are going to be
less inclined to do that. That is why
it is not specific about the values put against it. That is why there is no increase, is it not? This philosophy says the risks should be
carried more by organisations like yours in the future who say come to us and
we will buy if it is good enough and you can convince us.

Sir John Chisholm: Companies do invest and indeed we invest when
we can see a return in the kind of timescale that our own investors are
interested in. Where you cannot see a
near-term return then that is not a wise investment for a company to make,
though it is an entirely wise investment for a country because the country will
see the return from that in due course.

Q204 Mr Hancock: One of the arguments for your organisation
ending up where it is today, when we had these debates in this Committee some
years ago, was that you saw the reality that there would be less and less
investment in research coming from government and your organisation, in order
to stay as a leader in the field, would have to be able to go out and explore
the commercial world more effectively than you had been able to do in the
past. You still now want to appear to
be saying we will not do too much unless the government is going to front load
it. I cannot see how you can have it
both ways. You argued the case very
effectively for your own organisation at that time that you needed this freedom
to go off and do other things. It
obviously annoys your colleagues sitting behind because they are pulling faces
at what I am saying to you.

Sir John Chisholm: I think the figures I gave you do answer that
point. What I said a while ago was that
research funding has declined by 50 per cent.
I did not go on to argue that it should be recovered by 50 per cent
because I said there had been improvements made. One of the improvements made is the freedoms you gave to what
were the government labs to go out and modernise themselves and conduct other
business. Part of the consequence of
that is that we can do more for less than we used to. So there is an absolute gain that the nation has got through the
strategy it has adopted.

Q205 Mr Hancock: What do you see as the different roles
between an organisation like yours in the future in research and development
and what the government would be funding in research specifically targeted
towards defence?

Sir John Chisholm: We are a contractor to the government.

Q206 Mr Hancock: What else do you see your company doing in
the future which is going to mean your ability to continue to be at the
forefront of defence research still being available if you are not going to get
the same level of funding from government?

Sir John Chisholm: The point I was making is that we are more
efficient than we were before. One of
the reasons why we can do more for less for the government is that we are
engaged in winning business for our labs not only from the UK Government but
also particularly from the United States Government and also from winning
business in the commercial sector for that same technology. The funding mix for our laboratories is now
more broadly based than it was before and that is a net gain to the UK defence
vote because it is getting the benefit of the other funding coming in from
other directions and the stimulation of the research work within the labs from
that other funding.

Q207 Mr Hancock: How much is your organisation currently
spending in funding research and development in small- and medium-size
enterprises which are in this field?
What proportion of your expenditure on research yourselves are you
spending in the outside world?

Sir John Chisholm: I do not have the immediate figure at the top
of my head. We spend a considerable
amount of the monies that we get from our customers into our supply chain in
order to help us do our work. Typically
we will farm out a considerable amount of the work that we get into SMEs and
into universities in order to capture the best product that is coming from that
and in order to assemble that back to what is in the best interests of our
customers.

Q208 Mr Hancock: Do you see that in the future as being an
increasing trend? On Robert Key's
earlier point, would it be a policy that you would adopt that maybe in the
future you do not want to employ all these people and it would be far better
for you simply to be the prime server and you will sub-contract the research
and development elsewhere?

Sir John Chisholm: We certainly see ourselves as forming an
important link in the chain between our customers, who want a complete service,
who want a complete programme of research or development completed, and a
supply base which includes SMEs and universities, all of whom have got a
particular niche to offer. So we see
ourselves as playing a very important role in that gap between niche suppliers,
the universities and SMEs, and our customers who want a complete research solution
or technology solution provided to themselves.
That is why we are developing university partnerships and SME
partnerships which will enable the efficient capturing of those niche
capabilities.

Q209 John Smith: In your memorandum you identify a specific
failure in the DIS and that is that there is no sustainable policy for
developing Centres of Excellence for military related research. Could you expand on that a bit, and could
you suggest how you would see these Centres of Excellence developing?

Sir John Chisholm: Let me pick you up on the word failure for
the moment.

Q210 John Smith: Your word!

Sir John Chisholm: I think the DIS says that it is not designed
as a completely finished document, there are ongoing pieces of work and it says
that one of the ongoing pieces of work is in the science and technology field
and therefore I would have expected what we are now going to talk about to be
covered as part of that ongoing piece of work.
What we pointed to is that in covering that ongoing piece of work we would
expect the logic which has applied in other areas of the DIS to be equally
valid, that within the United Kingdom we need to be thoughtful about the
Centres of Excellence that we want to have for the nation. Mr Key mentioned previously the civil
research programme run by the Office of Science and Technology where the policy
is very much to focus on Centres of Excellence in the UK. I would have expected the same logic to
apply in relation to defence science and technology, ie that you would want to
encourage the Centres of Excellence and maintain those Centres of Excellence
rather than undermining them by spreading the available resources too thinly.

Q211 John Smith: Do you think there is an inherent problem
with trying to get government to invest in pure research within commercial
organisations as opposed to public bodies, for example our universities? Are you saying you want to see Centres of Excellence
develop in existing public research bodies, higher education or whatever, or
are you saying that government should be investing more in pure research or
blue skies research within commercial organisations like yourselves?

Sir John Chisholm: Yes.
I do not think there is any inherent excellence which exists in public
bodies or private bodies. Excellence
depends upon people and people are where they are. They can be just as easily employed in the private sector as they
can be employed in the public sector. I
am certainly not saying, as you imply, that Centres of Excellence only exist in
the public sector.

Q212 John Smith: Do you not think there is bound to be reluctance
on the part of government to invest in such open-ended research with commercial
bodies? You said earlier that not only
is less being invested and it is not covered adequately in the document but
that it is smaller scale and more detailed programmes that are actually being
undertaken and some of the bigger work is going to be ignored. I just wondered whether there is not an
inherent reluctance on the part of governments to undertake such research with
commercial organisations. Is there a
case for creating a defence evaluation agency to undertake such work?

Sir John Chisholm: There is a government agency called the
Defence Science and Technology Laboratory.
If you look at other nations, for instance the United States, it has no
difficulty at all applying government contracts to really excellent
organisations in the private sector and the United States does quite well from
that.

Q213 Chairman: Could I put to you a concern that I felt
about the flotation relating to the United States, which was that the United
States would feel reluctant to share, with what it might regard as a commercial
company in the United Kingdom, secrets that would otherwise have been quite
happily shared with an arm of government.
What would your response be to that?

Sir John Chisholm: Whether that is true or not, that was dealt
with when QinetiQ was formed out of the Defence Evaluation Research Agency (DERA)
and at that stage the specific government-to-government research collaboration
activity was placed in DSTL. Since then
there has been a very good symmetry between the US and the UK in that on both
sides of that research collaboration there are government officials, DSTL on
the UK side, the US to government labs on the US side, and the actual research
work on both sides has been predominantly done in industry. That is true on the US side and it is now
true also on the UK side.

Q214 Chairman: How much work is done with the United States
by QinetiQ at the moment?

Sir John Chisholm: In total it accounts on an ongoing basis for
about a third of our business.

Q215 Chairman: How does that contrast with the work that was
done before the flotation?

Sir John Chisholm: Nothing happened at the flotation. Before the vesting of QinetiQ and before the
introduction of private capital the amount of work done in the United States by
QinetiQ was very small.

Q216 Chairman: Have my fears about the cut off of American
work been realised?

Sir John Chisholm: We do far more work, for instance, with the
American agency, DARA, now than we did when we were DERA.

Q217 Chairman: That is what I was trying to get at.

Sir John Chisholm: In terms of what QinetiQ does for the United
States, it is far more now than it was when we were DERA.

Q218 Chairman: So the direct answer to my question about
whether my fears have been realised is no, is it not?

Sir John Chisholm: Correct.

Q219 Mr Hancock: Is that work that you are doing for the
American market done in the United States or in the UK?

Sir John Chisholm: We do it both in the UK and in the US.

Q220 Mr Hancock: You said 30 per cent of your effort is now
directed to the American market. What
proportion of that 30 per cent is carried out here in the UK?

Sir John Chisholm: The majority of the volume of work is done in
the US, but the research part of the work is done in the UK.

Q221 Chairman: You drew a contrast earlier when you were
talking to John Smith about the approach of the Defence Industrial Strategy to
the manufacturing sectors and that to research, technology and innovation. Could you describe that contrast?

Sir John Chisholm: In allocating government funds in the civil
research sector, which are predominantly allocated by the OST, their policies
have become strongly focussed upon placing the work in the country's strongest
research centres; that is a clear policy.
There is not such a policy yet, for the reasons that we have described,
in the UK because the Defence Industrial Strategy has not yet got to that
stage. What we are articulating in our
evidence is that we would have expected a policy of that sort to emerge both
because it is consistent with what the government's policy is on the civil side
and also because it is consistent with the rest of the DIS. When the DIS comes to consider other sectors
the DIS says that in order to preserve sovereignty and the ability of the UK to
provide the Armed Forces with the best products it should focus upon the areas
of real capability in the country.

Q222 Mr Havard: Are you familiar with this concept, which I
am only just grappling with, that Lord Drayson came out with about technology
trees? It seems to me that the
technology he seems to be describing starts fundamentally at the university
level and then the laboratories will feed into it and then the SMEs, up to the
prime who will deliver the product.
That is the production process, turning a concept into a process. The research part of that is implicit in
it. Are you familiar with this concept?

Sir John Chisholm: I am familiar with the concept.

Q223 Mr Havard: Is that something that is going to drive this
research and technology sub-strategy?

Sir John Chisholm: It relates to the answer I gave to Mr Hancock
earlier on, that in order to get from niches of technology into something which
is useful to soldiers, sailors and airmen at the end of the day you need an
integrating process and this is the tree that you referred to. We play a role in that tree in bringing
together technologies from the niches at the bottom end, some of which we do
rely on laboratories for but many we source from other people and we bring that
together into technologies which we ourselves insert further up the tree into
the equipment suppliers who often then insert that into the prime contractors
and the systems of systems integrators.
So there is exactly that tree where we play a role which is near the
bottom but not at the bottom because below us are the niche providers in the
SMEs and in the universities.

Q224 Mr Havard: So that is going to generate in part the
whole question about the placing of the funding and the processes that go with
the whole process then. Is that what I
am going to see out of a strategy that comes from research and technology?

Sir John Chisholm: I assume that that will inform the strategy.

Q225 Mr Hancock: This question is about the relationship
between your US customers and the British side of the organisation. We are constantly told about the problems of
technology exchanges and the restrictions that the Americans put on it. Are the same restrictions being put on you
with regard to British-based technology and the way you can share that with the
Americans?

Sir John Chisholm: We have to seek export licences.

Q226 Mr Hancock: Is that easier for you to get for the UK than
it is for you to get from the US to bring it to the UK?

Sir John Chisholm: I would just make a general comment. My perception is that it is an easier process
to go from the UK to the US than from the US to the UK, absolutely.

Q227 Mr Hancock: Is that going to cause you problems as more
of your market is in the United States?

Sir John Chisholm: We have a huge capability in the UK and
nowhere as strong a capability in the US.
So our strategy is very much focused on serving our UK customers and
also serving US customers from the UK.
That is good for the UK. Our
predominant technology flow is in the direction from the UK to the US. That is an issue for us because it sometimes
limits our access to the US and it limits what we can do in the US.

Q228 Chairman: Sir John, thank you very much indeed. Is there anything you would like to add to
what you have said or do you think that in your memorandum and what you have
been able to say today you have covered the ground?

Sir John Chisholm: You have been very generous with the time you
have allocated to me, Chairman. I am
very happy.

Q229 Chairman: Welcome to all three of you. We are very grateful to you for coming to give
evidence about the Defence Industrial Strategy. I wonder if I could start off by saying that in your memorandum
you welcome the DIS but you state that "It will be important for the MoD to
provide further clarification on what the report means for the whole of the
defence industry ..." Sir John,
welcome. Would you like to give us an
idea of what you would like to see by way of further clarification?

Sir John Rose: I think that will happen over time. The point is that this is a strategy
document and the key of any strategy is that it needs to be implemented, and we
will need to be very engaged with MoD, as industry and through the trade
associations who are partners with industry, to ensure that the steps are taken
and the changes are made both within the customer and within the supply base to
ensure that we achieve the objectives that have been pretty clearly set out in
the Defence Industrial Strategy.

Q230 Chairman: What about the fears that have been expressed
by some people that some small and medium scale defence companies might
gravitate to other sectors, such as the oil sector, do you have any views about
that?

Sir John Rose: In some ways I think the DIS should help
rather than hinder the SMEs. The whole
objective of the DIS is to create greater transparency about the opportunities
that are available to companies in their dealings with the defence
customer. As you know, if you are going
to try and make decisions about where you invest your money then having some
clarity about where you will get your returns is pretty important and therefore
this is a good first step in improving the transparency both for the larger
companies that interact with the MoD and for the smaller companies.

Q231 Chairman: You said in some ways the DIS should help
SMEs. Do you think there are ways in
which the DIS would not help SMEs or would hinder them?

Sir John Rose: I do not think there are any ways in which it
would hinder the SMEs at all. The big
step forward is in transparency.

Q232 Chairman: Do you think there is sufficient coverage
within the DIS of SMEs?

Sir John Rose: I think there is. We have got to be clearer about the role of the strategy and the
customer. The SMEs are part of a supply
chain. Some of them will be direct
suppliers to the defence customer and some of them will be suppliers to the
prime. In both cases it is helpful for
them to know the likely direction of investment either in the primes who are
their customers or in the MoD who is the direct customer. The SMEs were involved in the debate that
took place around the creation of the DIS largely through the trade
associations, of which they are members, but also with representation on the
DIC, so they got a good voice in the conversation. It was equally the case that the primes talked to their supply
base to try and make sure that they understood the direction that this debate
was taking, but my colleagues may have views to add to that.

Dr Howes: I think there has been a tremendous amount of
activity working with supply chains in the industry over the last few
years. Some of that is industrially driven
and some of it has been very driven by MoD itself as it has taken a greater
interest in supply chain relationships and supply chain management. I would agree with Sir John that the
direction that the DIS has given as to where the market is going, how the
customer wants to be, how it wants to buy, gives tremendous clarity for those
supply chain improvement programmes.

Q233 Chairman: Do you think the MoD and the DTI do
understand the supply chain and the best way to manage them?

Dr Howes: For the MoD it is the start of a
journey. I think there has been a lot
of honesty that there is not a tremendous visibility right down to the
bottom. I am not sure there could be because
some of the supply chains are very large and they are very complicated. That is just the world of defence business
as we see it today. So I do not think
MoD could expect to have complete visibility of that, but I think that it is
moving in the right direction in terms of working with industry to try and
understand those relationships. The DTI,
in extending that into the regions with colleagues in the RDAs and with the
devolved administrations as well, has tried to get a focus through things like
the Manufacturing Forum, the Aerospace Innovation and Growth Team and the Electronics
Innovation and Growth Team. A lot of
that work has gone on the effectiveness of the supply chain. So no longer is the DTI looking at companies
as isolated pillars but it is trying to look at performance across the supply
chain. I think we are all moving and
growing in the same direction. What the
DIS now gives us is the customer end to really stimulate the right kind of
supply chain improvements for the future.

Q234 Chairman: So the Defence Industrial Strategy is the
start of the journey for the MoD and the defence industrial policy was not?

Dr Howes: Following the publication of the defence
industrial policy the MoD did begin this focus on supply chain management and
supply chain relationships, but I think the DIS will give it the focus that it
needs. I think for me, in the document
itself, on page 28, there is a diagram in there that actually describes where
the MoD has been in its procurement and what its vision is. I actually think that this is a very helpful
diagram for us all and particularly for industry because this shows the extent
of the change. If you imagine the
implications of that in the supply chain, yes, it is the start of the journey
because there is clearly a lot to be done.

Sir John Rose: I think the biggest contribution to the SMEs
is the recognition that having a successful domestic industry is a key
objective. For the SMEs having a
successful domestic industry is crucial.
SMEs have a relatively short reach.
Many of them tend to be taken to market through the primes or the sub-primes
or the major integrators and that reach tends to be national and not
international because by definition they are small- and medium-size
enterprises, they cannot afford necessarily to enter other markets and it is
difficult to do so and expensive to do so and takes a lot of time. So the best thing for the SMEs is a
successful industry domestically.

Q235 Mr Borrow: The Defence Industrial Strategy is important
in the sense that it sets a framework within which industry can operate, but
the assumption behind the strategy is that industry itself will need to
reorganise and reshape itself to meet that framework. Could you say a little bit about how you see that reshaping taking
place and in which sectors there will be mergers and which sectors will be most
involved in that reshaping?

Sir John Rose: I think we all have views on that. I think it is impossible to predict. I think industry as a whole responds to its
customer. We do that in the commercial
sectors and we do that in the defence sector.
We will respond as an industry to changes that take place in the MoD as
a consequence of the implication of the DIS.
Clearly there will need to be changes in the MoD in terms of the way
that they operate with industry. I
could not possibly predict what will happen in terms of the central
consolidations in particular. All I
would say is that the nature of industry has been that over time the supply
chain has become more consolidated because at the top of the supply chain there
is a drive for simplicity. Let us take
as an example Rolls Royce. If we
developed an engine in the late Eighties we would have had 250 or more
suppliers; our latest engine has 71.
They are bigger and within that there have been some system integrators
who have taken on more responsibility and they need to be bigger because they
take on more risk, they have to take on the investment requirements, the
R&D requirements and so on. I think
the industry will simply respond to the demands of the customer in the way it
structures itself because that is what industry does.

Dr Howes: It is probably worth just saying that on the
whole when you speak to companies further down the supply chain the DIS is seen
as a good opportunity for industry to transform and to prosper as long as it is
able to invest and I think that will be the challenge over the next year as the
sector strategies begin to develop.
Many of them have milestones this year to do with setting up partnering
agreements and deciding the future. As
those begin to mature I think we can then judge what sort of reshaping there
will be in industry.

Mr Turner: I believe industry and businesses will go
where the market is. BAE Systems is a
global defence company. That is why you
have seen us expand in the United States, which is clearly the most important
market for defence research, technology and procurement. You have seen us expand in other parts of
the world like Australia and Sweden and South Africa and indeed we are now
investing in Saudi Arabia in line with the government requirements of the King
and the Crown Prince there to see investment in skills and employment at the
highest level in Saudi Arabia, and clearly there is a market in those
countries. The good news for the UK now
is that at long last we have a DIS in the UK and my board and my shareholders at
long last can see the possibility of a sustainable profitable future for the
business in the UK and that we can, as we do in other parts of the world,
supply the highest level of capability to the Armed Forces. That is what we are about, the highest level
of capability wherever we operate in the world to those Armed Forces in
America, Sweden, South Africa, Saudi Arabia and in the UK but also making a
return to our shareholders. Industry
goes where the market is and now that we have a DIS I think there is a strong
market in the UK which was not there previously.

Q236 Mr Borrow: Specifically on BAE Systems, you may not be
able to divulge very much at the moment, but is the Defence Industrial Strategy
affecting the way in which your company plans for the future and reconfigures
itself and reshapes itself within the UK?

Mr Turner: Absolutely.
The basic shape of BAE Systems has evolved over the last few years. You have seen us grow in the United States
because it is the most important market, you have seen us reduce our investment
in businesses in Europe because we believe that there is a real question mark
about the future of defence in Europe compared to other parts of the world, and
you have seen us investing in Saudi Arabia.
Now that we have this strategy in the UK I think there is real potential
for the UK defence industrial base which we did not see before.

Q237 Mr Borrow: There has been quite a bit of talk in the
press in the last year or two of a merger or some collaboration between BAE
Systems and another major company in the United States. Would you say that the Defence Industrial
Strategy affected those issues or is that still a live issue?

Mr Turner: I think what the Defence Industrial Strategy
has done is encourage BAE Systems to remain and to invest in the United
Kingdom. The talk in the press some
years ago about a merger was all part of a recognition by the board that we
needed access to US technology. The UK
no longer invests sufficiently in R&T, as I think has already been said,
and therefore we needed access as a global defence company to the world's most
important market. Clearly with the
weakness of my company a few years ago one way of accessing the United States
would have been by a merger with one of the big players in the United
States. I think that is far less likely
now. We are a much stronger company now
and we have managed to grow organically and by acquisitions in the United
States. We are now an $8.5 billion
turnover company in the United States.
We have access, therefore, to other technologies, to the market and
therefore a merger strategically is no longer necessary for BAE Systems.

Q238 Chairman: And you say it is far less likely.

Mr Turner: It is not necessary for us now to execute our
strategy by a merger, but it does take two to tango and at the moment I can
assure you there is nobody talking to us.
We will keep looking for organic growth in the United States and acquisitions
in the US. The budget going forward in
Congress for 2007 is $73 billion on R&T, it is huge and it is very
difficult to see how the UK and Europe can match that. If the UK Armed Forces are going to have the
very best capabilities that they must have to peace keep and peace make then
the UK has got to have access to the very best and that is what we intend to
do.

Q239 Chairman: When I asked you whether it was far less
likely, as you had previously said, you said it was less necessary but you will
still be looking. Can I press you on what
you previously said? Is it far less
likely?

Mr Turner: It is far less likely, yes, but not
impossible.

Chairman: I was not asking for a commitment written in
blood.

Q240 Mr Hancock: Sir John, can I take you back to your opening
exchange with the Chairman when you said that one of the benefits to small- and
medium-size enterprises would be transparency.
I was not quite sure I understood where the advantage would be in
that.

Sir John Rose: I think it is the simple business model. I think there is an assumption that the
defence business has been quite easy. I
think it has always been a very difficult business because it is quite
difficult to predict demand. It is
difficult to predict what is required, when it is required and how much will be
required. In the commercial sector you
have the ability to judge demand, you have population growth or travel, the
requirement for electricity or whatever it happens to be, GDP growth. If you are going to make investment
decisions, you want to do them with a sensible view forward of when you are
going to get a return. John Chisholm
made some clear points about the time to market and the time value of
money. If you make an investment and
you are significantly delayed in getting a return on that investment it is a
very bad thing for you and therefore transparency, visibility and being able to
make sensible informed judgments about where you are likely to get a return is
absolutely necessary for a company that has to satisfy shareholders, whether it
is private companies or publicly floated companies.

Q241 Mr Hancock: Would there not be a degree of nervousness
then for some companies reading this strategy, where it states quite clearly
that new platforms are to have long service lives, to learn that future defence
business will be supporting and upgrading them? That by its very nature would make it very difficult for some
companies to retain design and research capabilities that might have been there
if that was not the case. Most work in
the future will be on updating what is already on a platform rather than
bringing new platforms into place. Does
that not cause some difficulties for industry itself?

Sir John Rose: Oddly enough, I think it may be very
positive, the recognition that that is going to be what is happening and that
mid-life upgrades and so on, spiral development, is the way that we are going
to work and that continuous technology and insertion and improvement is the way
forward. The truth is that platform
lives have always been very long. The B-52
is likely to be based on existing commitments and 80-year old aircraft when it
goes out of service or it may even be 100-year old aircraft. It will have had technology insertions along
the way, but when it started people did not think like that. If we go into the process believing that
that is what will happen we will be prepared to take product to market faster
in its initial stages and then recognise that in time, as technologies become
available, we can upgrade and improve the platform, which is what we have done,
but it is a recognition today, right from the start, that that is the way we
are going to conduct business.

Mr Turner: It is a recognition of what the reality
is. There has been far too much
attention paid by MoD in the past to the initial side of procurement. When you look at the expenditure through
life, it can be up to four times on support and upgrades of weapons
systems. The fact that the MoD is
outsourcing more to industry because it can be done cheaper and more
effectively is a real opportunity for the supply chain to play a much more
significant role. I think it is good to
see the focus on through life support and upgrades. The fact that the primes in
the UK can now see a long-term future in that regard is not only a benefit for
the primes but for the route to market for the SMEs which is far clearer and
more specific than it has been in the past.
I think it is a very good thing.

Q242 Mr Hancock: The strategy also states that the MoD
themselves do not envisage needing to design and build a future generation of
manned fast jet aircraft beyond Typhoon and JSF. If JSF was to fail and not be delivered, would we be in a
position to marinise our own version of Typhoon? If we were to go down that line, in view of the French interest in
them buying one of the carriers, would we be interested in doing a joint
venture with the French on that version?
Is it something that industry has the capability to deliver or would
want to deliver? If we do not have any
capability or need for a fast jet aircraft in the future, how does the company
see their future in that regard?

Mr Turner: Of
course, we are talking about a long time into the future. We have a lot of work to do on fully
developing Typhoon. As you know, it was
initially designed for both air-to-air and air-to-surface capabilities. So far all we are doing is optimising the
air-to-air and, in due course, we will proceed to optimise the air-to-surface. There are many, many years of further
development for Typhoon and work for our engineers and for our shop floor in
the years ahead. Joint Strike Fighter
has a long, long way to go. It is a
very complex programme. It is an
excellent programme that we, BAE Systems, and, indeed, Rolls Royce are involved
in. There will be a lot of work for
many years to come. It is important, as
you know, that we obtain the technology in the UK from Joint Strike Fighter so
we can play that role in supporting and upgrading the fighter when it
eventually comes into service. I am
sure there will be delays on JSF - these weapons systems are incredibly
complex - and when it comes we do want to play a role in supporting and
upgrading it, but with Typhoon, with Hawks, with Nimrods, with JSF and with
exports we have a very significant future that we can look forward to.

Q243 Mr Hancock: The
Minister, in answer to a question yesterday in the House, said that they had
contingencies from A to Z on the understanding that if JSF did not materialise
they had a whole series, and he actually went through the alphabet, but did not
tell us what they were. I am interested
to know whether or not it is possible for you to foresee a situation where
Typhoon could easily be adapted. The
time is not that long. In eight years
we will have one carrier in the water.
There is no certainty that we will have the plane to follow for that.

Mr Turner: I am
not sure when we will have the carriers in the water. That is still to be determined.

Q244 Mr Hancock: The
Government gave evidence here saying that they were sticking to their
programme, which suggests that by 2014 there should be one of them floating in
Portsmouth harbour?

Mr Turner: We
are leading the programme and we do not know when we will be able to give an in-service
date or, indeed, a budgetary cost for the programme.

Q245 Mr Hancock: Maybe
we should have asked you, not the Minister.

Mr Turner: That
is where we are, and hopefully in the next 18 months we will have a better view
of the in-service date and the budgetary cost for the carriers. Indeed, it is possible to navalise
Typhoon. It is not what we would
recommend, because if Joint Strike Fighter proceeds, and we believe it will, I
think, in terms of capability for the Armed Forces of the UK, it is the right
aircraft, but, indeed, as Lord Drayson has made clear, there needs to be a fall-back
in case something goes wrong.
Therefore, we would suggest there should be an investigation into
navalising Typhoon as very much a fall-back solution. We do not see any other fall-back solution.

Q246 Mr Hancock: Is
that going on?

Mr Turner: No.

Q247 Mr Hancock: You
have not been asked to do that?

Mr Turner: No.

Q248 Mr Hancock: You
are not doing any work on your own bat on that?

Mr Turner: We
have done some work on our own. We know
that it is possible. What we need to do
is to do some more funding work to look at what would be involved in navalising
Typhoon, what the programme length would be and how much it would cost.

Q249 Chairman: But it is not just in case anything should go
wrong that there needs to be a fall-back, surely. If there is no fall-back, then it makes it more likely that it
will be harder to get technology transferred from the United States, does it
not?

Mr Turner: That
is my view.

Q250 Mr Havard: I
would like to ask you not about changes in industry but changes in the
MoD. The Minister has said in the past
that they would need to change also in order to accommodate the new
strategy. What is your view at the
moment of what the MoD is doing in terms of change? Are these changes taking place or do you see a static
organisation? What is your view of the
changes that are taking place in the MoD to accommodate the Strategy?

Sir John
Rose: I think it is too early, candidly.
The Strategy was only published in December. There is evidence of change already, but you have to remember
that you have got an organisation that has spent a long time operating in a
different way and, therefore, inevitably, it will take some time before the
sorts of changes that are implied by the Defence
Industrial Strategy really manifest themselves, but there is no doubt that
the conversation that took place between industry and the Ministry of Defence
around the DIS was as helpful a conversation as we have had in the last 15
years. It was conducted well, it was
very open, the way that it was handled encouraged openness on both sides and I
think the outcome of the Defence
Industrial Strategy reflects that.
Clearly, the Strategy is only as good as the implementation.

Q251 Mr Havard: Perhaps
we can come to that a bit later on. The
other thing, interestingly, that you said, Minister, earlier on was that perhaps
in the past the emphasis has been on acquisition and the changes are going to
have to be related to through-life processes and upgrades. The question has
been raised in the past that it has been too slow and too expensive in terms of
the MoD's response for industry and that the MoD's procurement processes and
decision-making processes need to be in some way revised. What is your view of that? We have taken some evidence about the DPA
and all the rest of it. There is both the
procurement decision-maker and the actual process that delivers it. What is your view of changes there?

Mr Turner: It
takes a long time. I think the big
companies like BAE Systems can afford to continue with studies and with
quotations and negotiations, but for smaller companies - I was on the
Board of Babcock's until last year - it is very expensive continuing to
run these competitions and delays happen.
Yes, we would like to see the acquisition process speeded up, but I
think fundamental to this is the investment that needs to take place at the
beginning of a programme's life. In the
past we have not as a nation invested sufficiently in derisking programmes and
establishing the realistic in-service dates and budgets for these programmes,
and that needs to take effect. We have
shot ourselves in the foot as a nation by going out there and saying, "It will
be in service then. It will cost so
much", but we have not done sufficient work.
These are highly complex weapons systems, as I have mentioned, and we
need the early study works, indeed, to see if the programme is viable or
not. We have not done that in the
past. I think with the DIS we are
moving away. There is a recognition
that we will be shooting ourselves in the foot as a country and undermining the
defence industrial base by making it look as if we do not give value for money
when in fact we do. If you look at the
value for money that the UK defence industrial base gives compared to anybody
else in the world in terms of cost and programmes and sophistication of
capability, it is second to none, and we need to stop doing what we did in the
past.

Q252 Mr Havard: The
Defence Industries Council is, presumably, a body that some of these
discussions will come back to in some fashion.
The Integrated Project Team, the whole question about project management
processes, has been at the heart of this whole discussion about the flexibility
and fleetness of foot, or otherwise, of the DPA and other processes. What discussion is going on in the Defence
Industries Council in relation to that?

Sir John
Rose: That is a very broad question.
The DIC is really about policy and strategic issues. It is not a programme management body. It is there to deal with the overview, as it
were. There is a breakdown structure
that goes below that and that will report into the DIC.

Q253 Mr Havard: It
presumably informs the work of the MoD itself and the DPA, and so on, in how it
should make its change?

Sir John
Rose: Yes, it does. You will remember,
we meet a couple of times a year at the NDIC and those meetings are now
scheduled in, we hope, for the next 18 months or so. We meet as a DIC reasonably regularly and we take input from the
team leaders who are interfacing with the MoD in the specific areas that we
have agreed that they should, but, ultimately, we are there to suggest strategy,
to inform policy and to monitor progress.
Sally, you are the Secretariat, why do you not add to that.

Dr Howes: There
are a couple of specific things that are now under way within the MoD,
particularly looking at acquisition change.
Tom McCain is leading a review looking at what change is needed to
implement the DIS. It is a small team
within MoD, which is appropriate, but industry is involved in that; so people
are contributing their thoughts about the acquisition process and their
experiences into that. That is on a
short time-scale - it is going to be reporting at the end of May. Certainly the outcome of that kind of work
is the sort of thing that the DIC would be very pleased to look at and to
provide comments on, but I think there is also something much more practical
and tangible that is going on which, again, was defined in the DIS. Two Pathfinder programmes were defined. These are activities where MoD and industry
will work together to explore what through-life capability management is and the
implications of that on the MoD side and on the industry side as well. Some of the joint industry MoD groups that
Sir John was describing were, if you like, the source of performing these ideas
during the last year. It was picked up
in the DIS, it is being taken forward now and we think these will be very
valuable experiences to push through.
They are not project-by-project, they are collections of projects, which
is also very helpful. It is trying to
find what the new acquisition processes should be.

Q254 Mr Havard: So
this is giving a real description of this diagram on page 29?

Dr Howes: That
is exactly right, yes.

Q255 Mr Hancock: Can I
go back to the point about derisking. I
think there is an issue there and I think the two carriers and the way that is
being done possibly is the start. Just
to give an example, the Astute submarine programme is a billion pounds over
budget and four years late. I cannot
imagine that the derisking on that would have been anything but very
expensive. Who pays for the derisking?

Mr Turner: The
derisking on Astute that GEC received was zero. They were encouraged to enter into a competition to design,
develop and supply three nuclear attack submarines with no prior knowledge of
any of that, and I think that it is completely wrong for the defence industrial
base of the UK. They clearly as a
company had a strategy to go into a prime systems capability. At the time it was the only way that MoD was
prepared to do business. What we are
now seeing, and what I think is well recognised, is that is the wrong way of
going about this business. Indeed,
Smart Acquisition many years ago recognised that investment upfront - derisking
- paid for by the customer: because it is the customer that has to take that
risk until such point in time as the risk is understandable by industry and
then industry can take the risk on.

Q256 Mr Hancock: But I
am interested to know who fixes the price for the derisking?

Mr Turner: There
is no price for derisking.

Q257 Mr Hancock: I
think you said the customer pays, but the Government cannot just say, "Tell us
what it is going to cost for you to take all the risk out of this"?

Mr Turner: No,
there are milestones. In a design and
development contract you have milestones for the programme and, as those milestones
are achieved, you then move on to the next milestone. These complex high-tech programmes have to be milestone driven,
and, yes, it is not an open-ended budget, but what MoD now do is allow a
certain amount of money to get to the next milestone and, if sufficient risk
reduction has occurred, you move to the next milestone. When you get to a sufficient point that you
fully understand the programme and have derisked it to an acceptable level, then
industry can step in and take the risk, but not until then.

Chairman: Can we move on to partnering
arrangements.

Q258 John Smith: My
questions are directed to Mr Turner.
In a number of areas now the MoD is moving towards long-term partnering
agreements. Your company is becoming,
in a number of cases, the sole supplier of these long-term contracts. Two years ago you told the Public Accounts
Committee (and you referred to it earlier), "There are far more attractive
markets in the United States if the MoD's terms of trade do not change." Have those terms of trade now changed, do
you think, to your company's satisfaction and, if so, in what ways?

Mr Turner: I
think what has happened over recent years is that the terms of trade have
changed in the way I have described with the customer (MoD) taking that initial
risk recognising that it has to take that additional risk in the complex design
and development phase and then industry taking on the risk when it is
understood. For BAE Systems, I think the change in the terms of trade and
the DIS actually having a strategy for the defence industrial base for this
country is very, very significant.
Whilst the US remains a more attractive market in terms of the attitude
towards profit and in terms of wanting industry to make a 15 per cent return on
defence contracts, where it is about eight per cent in this country, therefore
if you were starting from scratch you would not be investing in the UK, but we
are in the UK and we now believe that, with those profit rates only at
eight per cent compared to 15 per cent
in the US, there is sufficient attraction in sustaining the capabilities in the
UK now because of the DIS and because of the more acceptable terms of trade. In fact there are a significant number of
key plus points to come out of the DIS: the recognition of partnership instead
of competition, partnership that recognises the real issue is value for money
not just competition to find the lowest additional cost and then real problems
downstream, it recognises partnership, it recognises the importance of systems
engineering and integration at the highest level in air, land and sea - and
that is where BAE Systems plays a role.
The UK now is becoming a far more attractive market. Even though there are lower profit rates, as
I said, we can see a sustainable business in the UK forum for our company.

Q259 John Smith: I
think most people agree that the Strategy is welcome in terms of identifying
future market opportunities and in what direction Government is going in the
future in terms of its defence thinking, but one of our witnesses in an earlier
session suggested that the shift away from competition towards partnering is
not necessarily in the interests of your company or other defence companies in
this country in the longer term because you will not be exposed to such
competitive pressures in the UK domestic market. Is that a concern?

Mr Turner: No, I
think competition has been a disaster for the UK defence industrial base. I think, frankly, if it had continued, you
would have seen the end of prime systems capability in the UK, UK owned
companies. We are not in the fortunate
position of the United States. They
have a number of primes. They have
Boeing, Lockheed, Northrop, Raytheon, GD, and, indeed, now, BAE Systems North
America. All we have in the UK,
overwhelmingly, is BAE Systems in air, land and sea and, in fact, now we can
see a sustainable way forward with a strategy for the first time ever in this
country, championed by John Reid and Lord Drayson, and thank goodness for
that. If competition had continued,
allowing foreign companies to play the UK tactically, I think it would have
been a disaster in the long term, and you would have seen the exit of prime
systems capability in the UK with overseas companies offering lower-tier
technology to UK companies but then the through-life support and upgrade would
not be possible, it would be dependent on foreign entities.

Sir John
Rose: May I just add to what Mike has to say, which is that it is not only
partnership. I think it is really
important that we remember that the DIS is very clear that there are areas
where partnership is the right answer and there are areas where competition is
the right answer. None of us, as
suppliers to the MoD, can make sense of a business that is simply about
supplying, in a partnership arrangement, to the MoD. In order to be successful we have to have a product that is
capable of being sold overseas against competition. There is plenty of competition around, with no shortage of
competitive pressures in all the markets which we try and serve, including the
US, and, like Mike for Rolls Royce, the US is our biggest defence customer, and
it has been that way since the early nineties, so we have had plenty of
exposure to competition. The danger was
that the sort of competition that was being exercised here meant that you were
competing against a marginal cost supplier, in effect, and that does not make
any sense if you are trying to retain a sensible industrial base. That does not mean that you have to retain
all capabilities, it does not mean that partnership is the only answer, but it
is one of the answers, and that is what the DIS says.

Q260 Chairman: Mr Turner,
when you said that competition has been disastrous for the defence industry,
would you repeat it as baldly as that or were you referring to competition from
overseas?

Mr Turner: I
think that the competition policy of MoD allowed overseas companies to see an
opportunity in this market to wipe out the prime systems capability of the UK
indigenous defence base. BAE Systems,
British Aerospace, did not need a competition policy to say it needed to be
competitive globally. Look at how many
Hawks we have sold overseas, how successful we have been as a business in
exporting. I believe we are the number
one exporter from the UK. We only
export because we are competitive. We
are competitive in world terms.

Q261 John Smith: Again,
we have received a number of statements from witnesses expressing deep concern
about the future development of BAE Systems being in a position of the sole
monopoly supplier taking on board the views, in terms of international
competition, of a global market. A
number of very strong comments have been made in terms of BAE Systems possibly
developing a strangle-hold on British defence procurement policy and that this
document, the Defence Industrial Strategy
- and this is contained in written submissions to this Committee - conflates
the interests of a single British company with the interests of this country. What power does a British Government have to
retain your company in this domestic market if you choose to go elsewhere? It will have no power at all - not at
the moment, but this is a possible future scenario - because it has no
other supplier whatsoever to turn to within the UK domestic market. What are your views on that?

Mr Turner: BAE
Systems (British Aerospace) for decades has had a monopoly on air systems, but
it has been very good, very healthy for the UK. It has provided the best aircraft in the world in training and
fighting in fighters, and not only for the UK but for the world air forces, and
it has provided a very healthy income to the United Kingdom. It has been good for British Aerospace in
the past, but it has also been good for the UK. We have now a very significant position also in land and naval,
and I hope that we can go on in land and naval, as we have done for the past
decade, to be a success for BAE Systems in the UK. It has been very good news.
You are right, the Government has no real way of stopping BAE Systems
leaving these shores, but I can tell you that with the DIS, backed by John Reid
and Lord Drayson, it is now becoming an attractive place to do business, which
it was not. It was a very unattractive
place to do business in the nineties and the early part of this decade, and it
is now changing, and that is good. It
is good for BAE Systems and it is good for the UK.

Q262 John Smith: One
final question. One of our witnesses,
Professor Hartley, suggested that if this monopoly situation were to develop
extensively within the British defence market, there might be a case for
regulating your company as a utility.
Do you have a view on that?

Mr Turner: We
are regulated by, in 1968, the Ferranti affair, with outrageous profits. There was then the Laing Report that said
that we needed a profit formula based on the cost of production and capital
employed. That is what we have
got. We very much have a regulated
profit. I am afraid it is set at eight
per cent for my company, compared to 15 per cent in the US, but at eight per
cent, with sensible terms of trade and the DIS, we can see a return on capital
for our shareholders. We could not see
that before. We are regulated.

Q263 Mr Borrow: Can I
come on to the specific area munitions.
Under the DIS, BAE Systems have a dominant role in supplying munitions to
MoD. Obviously there is an issue at the
moment around the possible closure of Bridgewater and Chorley ROF sites. The closure of those sites would lead the
MoD to be dependent upon foreign suppliers for certain munitions because they
would no longer be produced by BAE Systems within the UK. I want to ask Mr Turner the extent to
which that is a problem for the MoD.
The DIS in many ways is seen as a document which strengthens and supports
the defence industries in the UK, but at the same time we are seeing, or
potentially seeing, the closure of capacity and dependence on overseas
suppliers for key parts of military equipment or, in this case, munitions?

Mr Turner: In
fact, we are being consistent with the DIS, because it is quite clear that the
MoD cannot afford to invest in R&T and procure everything from the UK
defence industrial base. In the case of
Chorley and Bridgewater, indeed, we are closing those sites because it is not
economic for BAE Systems and the UK to keep those sites open, but where we are
investing is in insensitive munitions, the raw materials (the explosive), when
they are supplied (hopefully from a reliable source), and, indeed, security of
supply will be an issue when we go to new suppliers for those raw materials. Indeed, the investment we are making in
mixing those explosives into insensitive munitions, it is a world-beating
technology that BAE Systems has and it is what we supply to the UK Armed
Forces. That is where the DIS is
focused, and rightly so, at the top end of technology, insensitive
munitions. We cannot afford in this
country to keep the supply of raw materials at an economic level. We cannot afford it.

Q264 Mr Borrow: Would
you agree that there is legitimate concern on behalf of the UK taxpayer and the
UK military that closure of these two facilities could take place before we
have actually nailed down and secured long-term supplies of alternative
munitions?

Mr Turner: We would not do that. There is no way that we would finish off
manufacturing the raw materials that we currently do without being fairly sure
that we had a secure supply for those materials for the UK Armed Forces.

Q265 Mr Borrow: Are
you in a position to give an undertaking to the Committee this morning that
Chorley and Bridgewater will not close until such time as a secure alternative
supply of those munitions has been sourced to the satisfaction of the MoD?

Mr Turner: That
is part of the process that we are going through now. Absolutely.

Q266 Mr Hancock: Why
is it that the product that we manufacture currently is not good enough for you
to export to keep the business going in the UK?

Mr Turner: We do
not demand sufficient of it in the UK, so we are below critical mass.

Q267 Mr Hancock: There
is not an export market for it?

Mr Turner: No. We cannot be competitive at that level of
technology, the raw material level.

Q268 Mr Hancock: Why
is that? What is the problem there?

Mr Turner: Because
other countries can do it cheaper and more efficiently in that area than we
can. We invest in BAE Systems in the
higher technology.

Q269 Mr Hancock: Is it
because of lack of investment in the past in these plants?

Mr Turner: We
have to be selective where we invest our R&T, and we have selected to
invest our money at the very top end of technology in systems engineering and
systems integration. I think it would
be wrong to invest in the bottom end of technology. That is not the future for this country.

Chairman: We are moving on to research and technology.

Q270 Robert Key: Mr
Turner, I wonder if you can tell us roughly how much your company does spend on
R&T.

Mr Turner: We
spend about £100 million of our own money on R&T in the UK and about £100
million of our own money in the United States on R&T.

Q271 Robert Key: Sir
John, I wonder if you can tell us roughly now much Rolls Royce spends on
R&T?

Sir John
Rose: We spend gross over £600 million every year, net about
£250 million, of our own money. About
20 per cent of our total R&D spend is on research and technology
acquisition, i.e. the raw materials of product development. About half of that is spent overseas and
half in the UK. We used to spend 100
per cent in the UK.

Q272 Robert Key: Those
are very impressive figures, and I would have expected nothing less from world
class companies, but is not that amazing compared to the British Government
spend of about £250 million a year on R&T? This worries me very much indeed: because right through the Defence Industrial Strategy, on almost
every page, there is reference to the importance of investment in R&T. It says nothing about increasing the
Ministry of Defence budget on R&T.
It says that we have now dropped to 1.9 per cent of our GDP spent on
R&T, it laments the fact that countries like China and India are going to
be increasing massively their R&T but we are not. Were you as surprised as I was that the Government made no
mention of any increase in R&T spend?

Mr Turner: I am
afraid it is all part of that disastrous policy that I talked about. We had Peter Levene, in the late eighties,
come in and say that we are going to have a competition and we are going to buy
more off-the-shelf and, as a result of that, we have stopped investing in this
country in defence R&T. This
country has had an absolutely tremendous return from the investment in defence
R&T, but I am afraid it is not a priority for this country any more. There is a very different attitude in this
country to defence and security than I see in the United States, and that is
why it is $73 billion in the United States next year and a very low figure in
the UK.

Sir
John Rose: I think you have got to read the DIS in
conjunction with the work of the AEIGT, which did have, at the end of it, a
recommendation that was endorsed by the MoD, the Treasury and the DTI for an
increase in spending. We have not seen
that come through yet, though there is some evidence that there is some
increase. In our case we have seen
something like a 75 per cent decline in real terms over the last 15 years in
MoD investment in R&T. It is part
of the point that Mike Turner made earlier about derisking. Historically the MoD invested in R&T
that was specific to the defence needs and in demonstrator programmes, which
were the mechanism for derisking. We
would like to see a return to that because it is very important for the
customer and for industry to prove technologies before their insertion, and
demonstrator programmes are the key mechanism for doing that. They have proven to be successful in the
past, they were key to the success of Typhoon, as an example, but those were
demonstrator programmes that were funded in the eighties initially. There is a recognition within the DIS that
there needs to be an increase in the amount of R&T spending and that there
needs to be a hierarchy that involves the universities, that involves industry
and involves the industry partners and involves the MoD. I would just make one slight
correction. The tree that you talked
about does not have universities, then SMEs, then primes. Very little R&T takes place in
SMEs. They participate in some R&T
programmes, but it tends to be driven by the larger companies, and the
universities are a key part of that.

Q273 Robert Key: The
DIS talks too about the importance of looking towards Europe in relations both industrially
but also in terms of research. There is
quite a lot of duplication in research and technology, is there not, across
Europe? Would it be practical for this
country to take a lead perhaps in rationalising that, preventing some of this
waste in the same way that you suggested there has been a lot of waste in the
previous models of defence procurement in the past? Am I right, first of all, in your experience, that there is
duplication across Europe?

Mr Turner: There
is duplication. You have seen that with
Rafael, Typhoon and Gripen. I think the
fundamental problem, though, that Europe has got is that it is just not
spending enough on R&T generally.
There is duplication, yes, but when you compare Europe with the appetite
for spending on R&T in the United States, the great concern that we have
for our Armed Forces is how are they going to get the capability to be able to
peace-keep alongside the United States?
That is why we have stressed that when we do acquire from the United
States, as we will have to in certain areas because we clearly cannot afford
everything in this country any more, we need to get the highest level of
technology transferred across to the UK to sustain the capability for the
support and upgrade through life. Yes,
there is a case for trying to get Europe to get the act together, but who is
going to move first? Everybody wants
the technology in their country, everybody wants the highest level of
technology jobs in their country and there is a very limited amount of resource
available anyway for doing it. I am not
optimistic about that.

Q274 Mr Crausby: Sir
John, the Defence Industries Council tells us that it is keen to work
constructively with the MoD to ensure an effective implementation of the Defence Industrial Strategy. How involved is the DIC with the
implementation of the DIS and are you satisfied? Is it clear to industry who is responsible for implementing the
various aspects of the DIS and in what timescale? The SBAC suggests that ministers are looking to a two-year period
for the implementation. Do you agree
with that? How will industry in the
long-term measure the success of the Defence
Industrial Strategy?

Sir John
Rose: I think we would all like to input to that answer. I would start by saying that I think Sally
Howes has covered a lot of the answer in her earlier comments. We have got the first of our post DIS/NDIC
meetings tomorrow. We will have regular
meetings with the MoD, and tomorrow very much on the agenda will be trying to
work out exactly how we do monitor the progress, but clearly the big items are
going to be do we see change in the effectiveness of the programmes that are
delivered, do we see changes in the way that MoD procure and are structured and
do we see changes in the way that industry interfaces with the MoD? There are going to be a lot of a sub-mechanisms,
as Sally mentioned earlier, where we look at different components both through
the DIC mechanisms but also in terms of the individual company's interface with
the MoD.

Dr Howes: I think
all of the actions that were suggested in the DIS are being undertaken one way
or another. We are satisfied that the
bases are being covered. It is very
clear that this is going to require some strong leadership to keep all of this
together during the period. As Sir John
mentioned, the NDIC is scheduled to meet four times rather than two, which is
normal, this year, and we have an agreed timetable for check-points and for
looking at the progress of the implementation itself. I think it is early days, but we see activity under each of the
headings.

Mr Turner: I can
tell you what is happening in BAE Systems on implementation. On air, land and sea, clearly where they
were specifically clear in the DIS on the future importance of the highest
level of systems engineering and integration in the UK, we have a very senior
lead within the company on air, land and sea in discussions with somebody in
MoD, appointed by MoD, to agree the partnering arrangements, milestones, in
taking the DIS forward. We were fortunate
on the land side that Lord Drayson and I, on the day of the announcement of the
DIS, signed the milestones for taking land systems support and upgrade forward,
and we are now working together on the air side and on the naval side to put
similar partnering arrangements in place, to set milestones in place, to prove
that we can deliver, as we say we can, against certain milestones. The biggest issue for us, though, is the
cultural one, the relationship over many decades now between the DPA and industry. That is where there has got to be the most
radical change. We approved, in
partnership with the DLO, that there are great savings to be made on support
and upgrades by working in partnership to improve the availability of Nimrod Mk
IIs, of Harriers, of Tornados, at reduced cost to the taxpayer, and we believe
that, by working in partnership and working in a similar way with the DPA, we
can deliver savings to the taxpayer on the initial equipment, but I think that
is a big challenge.

Chairman: That is very helpful evidence. Thank you all very much indeed for coming
this morning.

Witnesses: Lord
Drayson, a Member of the House of Lords, Minister for Defence Procurement, Mr
David Gould CB, Deputy Chief Executive, Defence Procurement Agency, and Mr
Mark Gibson CB, Director General, Business Group, DIT, gave evidence.

Q275 Chairman: Minister, gentlemen, welcome to the Committee
to talk about the Defence Industrial
Strategy. The Defence Industrial Strategy was originally expected on 20 December,
and I think you produced it four days earlier.
Minister, I ruined your career, I suspect, by praising you in the House
of Commons and saying that it was the first procurement project that I had
heard of that actually came in early, yet it was produced at quite a lick. Given that, do you feel that there were any
areas which, perhaps because of the quick time scale, were insufficiently
covered within the Defence Industrial
Strategy? I ought to say in context
that it has been generally well received, but, having put that in context, are
there any areas which were not as well covered as you would have liked them to
have been?

Lord
Drayson: Thank you, Chairman. Before
answering your question, may I just say that it is with deep regret that I
confirm the death of two British soldiers killed by terrorist bombs as they
carried out their duties in Iraq this morning.
Our thoughts and our deepest sympathies are, of course, with the
families concerned.

Q276 Chairman: I am sorry.
I was not aware of that. Thank
you for mentioning it.

Lord
Drayson: Chairman, I appreciate the comments which you have made about the DIS,
and you are absolutely right that we set about delivering the DIS to a very
tight timescale. The reason why we did
that was because we had had clear feedback from industry that they were going
to be making decisions towards the end of the year, into the early part of this
year, where there really did need to be a clear framework as a good basis to
take those decisions. We also knew that
we had some important decisions to take on some of our key procurement
projects, for example, like Carrier, which were far better taken in the context
of the DIS. Therefore, it was important
that we delivered it by Christmas. In
terms of which areas do I feel were not sufficiently covered, I think we need
to recognise that the DIS focused on the areas which we regarded as being the
most high-priority in terms of the issues which we were faced with, and
therefore there was a difference in terms of the depth into which we went in the
different sectors reflecting the relative market conditions and the issues
which we faced. Answering your question
directly, we do see that there is further work which we need to do to build on
what is in the Defence Industrial
Strategy around areas such as research and technology - I am happy to
go into the detail of what we are doing on that - in terms of areas
related to small and medium-sized enterprises and the relationship between the
Ministry of Defence and SMEs. These are
areas which are covered within the DIS, but we certainly feel that they are
areas which we need to further build on quickly this year, and we are doing so.

Q277 Mr Havard: Can I
pick up the whole area of SMEs. It
seems that the Strategy is an overview strategy in a sense. Within it there are other strategies
presaged, like the Maritime Industrial
Strategy, and so on. One of the
things that interested us was which sort of sectors were involved or not
involved. What you are saying is some
are more heavily involved than others, but this question of how small and
medium enterprises were involved is of particular importance. It has been suggested to us, for example,
that some of the small to medium enterprises might look to gravitate to other
sectors because they find it too difficult participate in the long term in
the defence industry. What is your view
of how SMEs are going to be given proper visibility and avoid that problem?

Lord
Drayson: I believe that it is vitally important that we do everything that we
can to improve the way in which we work with SMEs. I have 20 years' experience of growing and building technology
companies from start-up and beyond, and I know how challenging it can be. In this particular industry, because for my
SMEs their route to market is through the larger companies, the primes, I think
there is a dual responsibility, which is clearly set out in the DIS. There is a responsibility on Government, on
the Ministry of Defence, to actively work to find ways to provide the clarity
and transparency in an efficient way that small companies, who do not have the
resources of larger companies, can digest and manage effectively, but there is
an equal responsibility on the part of the larger companies, who are often
their route to market, to provide that clarity too. The way in which we are actively doing that is to switch our
focus from a specific focus around projects and about companies in terms of
looking at the supply chain, and so one of the ways practically we are going to
improve this is by assessing the larger companies on the basis of how good they
are at having real knowledge of their own supply chains, how good they are at
being able to explain to us the technology trees that they have in certain capabilities
such that we can see the relative effectiveness of the larger companies in
having a real understanding of which SMEs are vital to the production of the
defence capability. Also within the
Ministry of Defence - it is not published within the DIS, but a lot of
underpinning work was done on the DIS in terms of fully understanding these
supply chains - we have gone into a lot of detail in the individual
sectors and asked ourselves the question: where are the really important areas
of skills and knowledge, which companies are they located in and do we have
proper visibility of the health of those companies and how they fit into the
bigger picture? That is something which
we have done in a considerable amount of detail and that is something which we
are going to continue to build on. We
also need to make the MoD easier for SMEs to deal with, and we have done that
by issuing on our website a sort of "who's who" such that small companies can
easily look up, if they think they have a service or a product which may be of
interest to the MoD, who they need to contact.
It is the first time we have done that.
That is another example of how we are trying to make ourselves more user-friendly
to the SME community.

Q278 Mr Havard: It
was suggested to us this morning that part of the difficulty that SMEs who
would like to participate in these areas, and do (and some people do not
understand that they do currently actually), is that they have national reach,
they do not have international reach.
There is a responsibility to involve them from that point of view. They cannot really get involved in an
international defence market because they do not have the resources to do it.

Lord
Drayson: I have spent some considerable time looking at this, and I have been
quite impressed when I have gone to see small companies. There are some excellent British small
companies who successfully compete internationally in specialist markets -
they are really good at it - and we need to make sure that we give them
every support that we can. I think we
have a very effective organisation in derisking which is pretty much unique
within the international market, but when you look at these supply chains it is
very clear that in many areas of defence capability there are some vitally
important small and medium-size enterprises, and we need to make sure that we
have got a clear focus on this, and I think we need to improve the
visibility. One of the interesting
things for me, coming from the pharmaceutical industry into this job and
looking at the Defence Industrial
Strategy, was some of the feed-back which we got from the stock market analysts
about the defence industry and the lack of clear visibility in the mind of
investors of how smaller, innovative, high-growth defence companies grow into
larger ones because of the nature of the complexity of the systems, and so
forth. I think we need to do more to
help the industry have that visibility.

Q279 Mr Havard: The
accusation, if you like, that has been made by people who have given evidence
to us is that the problem is that you have visibility to some degree of the
first level of the supply chain but you are not so good at understanding the
second, third levels. If your
declaration is that these people are going to help them deliver the key
industrial capabilities, you need to get underneath the first level and down to
the second and third level. As I
understand it, you have made speeches elsewhere and you talk about a commercial
services group being established, you talk about work with the trade
associations, and so on. Are these part
of the mechanisms you are describing to do this work and how is this work going
on, apart from what you have already described?

Lord
Drayson: I have a personal commitment to make it happen. I have some experience in helping people at
the other end in terms of running these sorts of companies. I know some of the challenges from my
own personal experience, and what I am driving in the Department is a real
emphasis on looking at the way in which we do business, coming up with specific
actions to make it easier - I have mentioned some already. We also need to recognise what the
Department is already doing. If you
look at government policy in terms of the proportion of contracts which the
Government would like to see placed with small, medium-sized companies, the MoD
spends way more than that, so we are already spending a considerable amount of
our defence contract with the small, medium enterprises. We have got a range of initiatives in
place. The DIS sets out how to do this,
if you like, for 2006 and all the things that we are doing, and it is my job,
in terms of being accountable for the implementation of the DIS, to see that
these things happen. What I am looking
for is that next year (2007) we are starting to see evidence that it is making
a difference. I am actively spending
amounts of time talking to that community, getting that feed-back to make sure
it is making a difference.

Q280 Mr Havard: You
have said that you are "assessing" companies in terms of how they actually
manage this process themselves, the larger companies, the primes, and so
on. As I understand it, you have made
statements about the joint management of SMEs by the MoD and the primes. I am not quite sure what that means. All of that is all very well, but the MoD
presumably, which you have responsibility for, is changing its practices and
taking a particular view. How is that
being done in concert with the Department of Trade and Industry?

Lord
Drayson: It is very important that this is joined up government, and the DIS
sets a good basis for this. This was a
joined up process, and we have taken on board a lot of the input which we have
had from the DTI on the way in which this is done. It is important for me to stress that it is not about managing
companies. It is not our job to manage
companies, but it is our job to make sure that we properly understand and
manage the complexity of the supply chains.
The challenge within defence is many of these systems which deliver the
military capability are very complex and involve many different companies coming
together effectively. The way in which
we do that jointly with the large companies is both the MoD and the larger
primes having clarity on, for example, the technology tree. If you take a particular capability and you
look at what is the tree of support for that technology going right down into
the research, sometimes into the universities themselves, you have clarity over
that and the way in which we judge a large company is on how well does that
company really understand this and does it actively manage it. If not, this is where we need to work
together to encourage that to be done better.

Mr Gibson: To
add to that from a DTI perspective, we have a small aerospace marine defence
team of about 25 people, with about five people working on defence, but we do
have a formal relationship management with the 15 largest aerospace and defence
companies. We have quarterly meetings
with them and we have reinforced the messages in agreed Government documents
like the Defence Industrial Strategy. We also work pretty closely with the
regional development agencies, who have clear sector leads now to the south-west
RDA, and we expect them to have a good relationship with the supply chain and
to work with them to try and improve productivity, and there are regular
meetings between the DTI's aerospace and defence team and the RDA contacts who lead
in this sector. We are trying to
reinforce the messages all the time, both in the primes and through the RDAs,
with the supply chain.

Chairman: So the sector lead for defence is in the
south-west.

Q281 Mr Havard: For
England.

Mr Gibson: For
England.

Q282 Chairman: BAE Systems is based all round the country
but its centre seems to be in Wharton, which is not in the south-west. How does that work?

Mr Gibson: The
north-west RDA does take a really close interest in the aerospace
industry. The Chairman of the north-west
RDA is Bryan Gray, who is on the Aerospace Leadership Council. He has been involved in the whole aerospace
strategy for the last three or four years and he takes a particular interest in
aerospace issues; so he is closely involved and talks to BAE regularly in the
north-west.

Q283 Mr Crausby: The Defence Industrial Strategy states that
industry will need to reshape itself, and you, quite rightly, are demanding a
substantial change in a number of sectors.
Is industry willing to reshape itself into the shape that you require,
how painful will this be in terms of jobs and over what timescale do you
envisage that reshape?

Lord
Drayson: This is a ten-year process. The
point of the Defence Industrial Strategy
is to set out clarity to industry about those areas in which we expect to have
an increasing requirement, those where we expect a decreasing requirement to
take place and to give industry that clarity to enable them to plan ahead. This is not about changes happening
tomorrow, next month, this year. It is
about changes which need to take place over a period of time to get alignment
between the defence industry's capabilities and our capabilities in terms of
our security and defence priorities. The
pain comes from that change, but change is always painful. One of the big changes which we are asking
in some sectors is for industry to put less of a focus on the design and
development of new platforms and more of a focus on the insertion of upgrades
and new capabilities and through-life maintenance of existing platforms. That is, for some companies, a change of
culture in terms of their type of business and that is difficult for them to
do. It is for industry, though, to step
up and do it. It is not, we believe,
the role of government to manage this process.
The role of government is to set out, as we had in the DIS, what it is
we need, what our priorities are, where we regard it as essential to our
defence interest to have a capability in the United Kingdom and then to expect
industry to respond to that. The
pressure on industry to do so, I think, will come both from the fact that this
clearly sets out where the key growing markets are, and you would expect
management to therefore reflect that.
We need to work with industry to facilitate this process and to manage
it as well as possible, and I am saying to industry, pretty bluntly, this needs
to start now. The evidence that
industry is responding to it, I think, is beginning to be there. I have been encouraged by what I am seeing
just in the first few months after the publication of the Defence Industrial Strategy.
In some sectors we are asking for companies to come together into
structures to address inefficiency. It
is patchy, as you would expect. There
are some companies who are looking to see whether or not this is really going
to happen and then really getting involved in it. There are some companies who seem to really get it and are
getting on with it now. Our job within
the Ministry of Defence, and my job in particular, is to encourage them that
the Defence Industrial Strategy is a
plan for action, it is not just a policy document and that we do expect
industry to respond and get on with it in 2006.

Q284 Mr Crausby: Is
there a danger that some companies will focus on a non-defence future, the
companies that want to do that, and that the reshape will become a different
shape to the one that you really want?
How do we protect ourselves against that risk?

Lord Drayson:
We have set it out very clearly.
We have said that the number one priority, as set out in the Defence Industrial Strategy, is putting
the defence needs first. That is
something which has been a real achievement of the DIS, giving industry the clarity
of how our defence capabilities are going to be linked to the defence needs
going forward, and we have said very clearly that we have come to the
conclusion that having a healthy defence industry in this country is
strategically important to our defence interest. Therefore what we are indicating is not a decline in the demand
for defence products, we are indicating where the shifting priorities are as
the world is changing. That gives great
opportunity to industry. In fact, the
way I would put it to industry is that, given the nature of the clarity which
the UK has now given, given the nature of the tempo of operations which our
Armed Forces undertake, if industry responds to the DIS, it is going to lead to
it producing products and services for which there will be a clear world
market. Some of the responses we have
had from some of the international pilots which we have to the clarity of the
DIS back that up. I do not think we
need to be worried about companies exiting the defence market and looking
towards the civilian market, and I think the way in which we have seen
commentary about the DIS in the press and analysis suggests that that is
correct.

Q285 Mr Hancock: Could
I take you a little further down that road.
You said in an article fairly recently that there will be job increases
in some sectors but inevitably there will be job reductions, but you were not
specific about which sectors you were talking about. In an area like mine - I represent Portsmouth which is
heavily dependent on defence industries - that would send nervous shivers
down people's spines. Would you care to
clarify that a bit more today?

Lord
Drayson: Yes, I will give you two examples, one of each. In terms of where we think that there are
going to be job decreases, it is going to be in areas such as the complex
weapons area whereby we can see the decreasing need for a certain type of
weapon, and so we are working with that industrial sector, who have very
important skills, which are not just relevant to complex weapons, and looking
to encourage them to be using those skills in areas where we have a growing
demand. I must say, from the maturity
in the response in that particular sector, that is a sector where we have seen
industry responding very well and I am optimistic that it is going to be
possible for us to manage that process effectively. Nonetheless, we are going to see a decrease in requirement in
that sector. To give you an example, a
sector where we see an increase is in shipbuilding, the maritime sector. There the challenge is that we need to
ensure that the way we manage the increase which is built upon the very strong
shipbuilding warship orders which we have over the coming years does not create
an unsustainable level of employment which is then going to go into a bust
situation after boom. We have got many
years to plan this well. Therefore,
when you are in a situation like this where we can see increasing orders,
increasing demand, we need to be intelligent about using that period to make
sure that we are getting real efficiency into the industry and that we do not
create an unsustainable level. Do you
want to add anything to that?

Mr Gould: One
point I want to add is that the nature of the defence industry is changing over
time quite dramatically. There is a bit
in the DIS that talks about the amount of defence activity that is open to the
private sector. If you go back 30
years, it is really just the manufacture of defence goods, then you get into
the services and now increasingly you find the private sector involved. For example, in military communications
right from here in the UK up to day-to-day operations in Iraq the private
sector is involved; so there is an expanding scope of work available to the
private sector in defence which will enable us to build up. A lot of the companies involved in that, of
course, will be involved both in defence and in civil because the technologies
in communications and elsewhere are very similar and feeding off each other.

Q286 Mr Hancock: Can I
ask Mr Gibson the role of the DTI in managing the change in those various
sectors and where you fit into the matrix of change that is going to take
place?

Mr Gibson: We
fit in in the same way that we fit in for other sectors of British
industry. Where there are large
industrial closures - MG Rover is an example - we expect the RDAs to look
closest to the ground to work with the local arms of other government
departments - Jobcentre Plus, Learning and Skills Councils - to pull
together packages which help the workers who very unfortunately lose their jobs
to gain opportunities elsewhere.

Q287 Mr Hancock: Could
I come back to you, Minister. You
rightly raise the issue about the shipbuilding capacity, and the horizon looks
very bright for the Type 45s and the carriers there, but, as you rightly say,
we have to plan for what happens after that.
With the way in which the ships are being designed now there is little
chance of much of a follow-on to increase the number of surface ships the Navy
will require. How do you envisage the
MoD working with industry to prepare for that downturn that will come post 2014
or whatever the date is?

Lord
Drayson: We have analysed the ship-building industry in this country and we can
see that we have got companies and yards which are absolutely world-class -
there is no doubt about it - and are able to go toe-to-toe against
international competition and win.
There are other areas where they are not as efficient as they need to be. When you look at the overall industry, it is
clear that too much of the industry is represented by the MoD as a
customer. What we want to see is that.
by the changes which we encourage in the way in which we work with industry
over the next ten years, we help the industry to become more internationally
competitive, we see the spread of best practice throughout the industry, such
that industry is able to win more orders from other customers apart from the
MoD. What we have seen in the DIS is a
focus towards a high value-added end of the ship-building industry. That is the area which we believe we can
really compete in, the area of complex systems integration. I have visited yards and seen, for example,
the Astute submarine build and you see the complexity of that vessel - it
is more complex than the space shuttle and a lot more modern and it is British
built - so there is no doubt that our industry can do this, but we need to
get best practice throughout the industry and I think that then will provide us
with a sustainable industry into the future, and that is what we are aiming to achieve. I think we have the time to do it. The key is the implementation of the Defence Industrial Strategy and the Maritime Industrial Strategy particularly
through this year. 2006 is a very
important year, because there are some important milestones on some of the
projects which we are working on, not least of all Carrier. Carrier is going to be one of the ways in
which we are going to help to encourage and drive this process, and I am very
focused on making sure it really does happen, but I think the opportunity is
there.

Q288 Chairman: Minister, I understand that when you were
talking to the Defence Manufacturers Association last week you said, in effect,
that you were "a man in a hurry". I
hope that Mr Gould will keep his ears shut when I ask this question. Do you find that your officials are in as
much of a hurry as you are?

Lord
Drayson: I think they are getting there, Chairman, yes.

Q289 Chairman: You have also said that you recognise that
the Ministry of Defence has got to change.
In what respects do you think that the Ministry of Defence has got to
change and how do you think those changes will be put into effect?

Lord
Drayson: I think that the industry has to change and the MoD has to change - that
is the point - but I think there is a duty on the MoD to demonstrate through
its change that it is serious about the Defence
Industrial Strategy being real. If
I was in industry running one of the defence companies, I would be looking
carefully to see how quickly the MoD is getting on with the things that it has
promised to do. The way in which that
is happening in the Department I am actually seriously encouraged by, and I aim
to surprise this Committee, if you like, in the future by the pace of change
which we are able to achieve in the Ministry of Defence. Why do I say that? Firstly, the way in which the MoD responded to the challenge of
getting the Defence Industrial Strategy
published in the timescale, the way in which it went about that, and the team
of people that were responsible for it, I believe, did an absolutely
outstanding job and I saw real excellence in the Civil Service which I think
industry then responded to. We have set
out a "to-do list" of changes and we have set timescales. The Permanent Secretary has put a small
targeted team of people to look at the whole acquisition process, based upon
what we have set out as principles in the DIS, and to report back by May on the
changes which we need to make, building on the improvements that have been made
to date. Things like Smart Acquisition,
the series of improvements in procurement which have been achieved by this Department
have been good, in my view. It is about
building on that and going further. In
June, Chairman, we should be seeing the outcome of that as one example. The impression I get within the Department
is that it is the recognition of the changing environment, and it is the changing
environment that we face, in terms of the threat of globalisation and
increasing complexity of technology, which requires MoD to improve. Your Committee and other committees have
said that when the MoD does things well it is a real gold standard. We need to make sure that that practice is
spread more evenly, and there are some very clear things which we need to do to
achieve that in terms of increasing things like commercial skills within the
Department. The whole emphasis on tough
commercial partnerships in the DIS requires the Department to have the people
with the know-how to manage those types of relationships. We need to ensure that that happens. The way in which the Department tends to be
very good at the urgent operational requirement, tight procurement process,
very good indeed, but less good at some of the longer term projects means that
we need to come up with processes which take the best out of the UOR process
and apply them more effectively to the longer term projects. There is a whole list of things - a to-do
list - which is set out in the DIS. The
impression I get is that the Department is really up for this change. Both industry and the MoD recognise that we have
an opportunity here to make a step-change in performance. The DIS has given us a good framework and an
action plan to do that, and what I am seeing is that the Department is
responding. The way in which I think we
should be judged is in the quality of the decisions that we take and the
difference we actually make to procurement.
What I have said both to the Department and to industry is that 2005 is
the year we came up with the Strategy, 2006 is the year that we seriously
implement it to be able to show results both to your Committee, Chairman, and
to others who scrutinise us, that we really have made a difference. When I say I am a man in a hurry, I am in a
hurry to show in 2007 that this has made a real difference to our defence
capability and the strength of our defence industry.

Q290 Chairman: You may have read that some witnesses in
front of us have said that there was more information provided to the defence
industry in the United States when the United States took some of its
procurement decisions. The Ministry of
Defence used to be more forthcoming in relation to its future intentions, its
priorities and its plans. Do you think
that that is a fair accusation? Is the
Ministry of Defence planning to be more forthcoming in relation to its
priorities and its plans?

Lord
Drayson: Yes, it is. The DIS sets out
explicitly a recognition that there needed to be more transparency because
industry did not have enough clarity to be able to make the investment decisions
which were going to drive the improvements which we needed to see. Without going into the historic reasons, I
think it also reflects that the relationship between the MoD and industry was
not as effective as it needs to be, and I think that the DIS has made a
positive difference to that, and that is something which we need to build
upon. We also need to be mindful that
some of the things which the United States has done in terms of the release of
information has had some negative consequences, and we were very mindful to learn
from that. For example, I was very
concerned to make sure that in going into the gritty detail which I promised in
the Defence Industrial Strategy we
did not make the mistake of providing such clarity over where we saw the really
smart, young, innovative companies that we will provide a shopping list of
acquisitions for bigger companies. We
need to be careful. We do need to push
the transparency issue consistent with our security interests, but also being
intelligent about the global market place which we operate in and making sure
that we do this in a way which helps companies provide solutions to our needs
without actually making life more difficult for them.

Chairman: We are moving on to the issue of
sovereignty.

Q291 Robert Key: Minister,
I found one of the more intriguing chapters in your Defence Industrial Strategy B1 on Systems Engineering and I would
like to ask you a little bit about appropriate sovereignty. Obviously, if we are going to retain
sovereignty over a proportion of our production and systems, it is going to
come at a price. Has the Government
thought how much? What price? Whether it is a five per cent premium, a ten
per cent premium, a 20 per cent premium.
Can you give us a little more of your thinking on what you mean by
appropriate sovereignty?

Lord
Drayson: Yes. We did a thorough analysis
of the defence market by sectors and we looked at it from the perspective of,
in a particular sector were there defence capabilities which we regarded as
being so strategically important to our defence interest and where we were
concerned that not having those capabilities on shore may lead to others having
an impact on the operational freedom so that we had to have that done here in
the United Kingdom, and so we set that out.
We have also said very clearly that we do have and want to have one of
the most open defence markets in the world.
Therefore, we are not concerned about where the shareholders owning
these companies live, but we are concerned in certain areas where the
intellectual property resides, where the design authority is held. What we have found, and this is why a
section on systems engineering is so important, is that as defence equipment is
moving in a direction where the actual platform, such as an aircraft or an
armoured fighting vehicle, may be in service for a considerable length of time,
decades in some cases, the subsystems - communications, sensors and so
forth - which really deliver the advance military capability have a much
shorter life cycle and therefore need to be upgraded much more frequently. We need to have the capability in this
country to do that, which is why systems engineering skills are important in
this country, it is why we need to have clarity when we go into a project -
FRES is going to be an important example - that we know where the
intellectual property is held and that we manage intellectual property linked
to the delivery of freedom of operational capability. To answer to your question about price, we
then rely on the market to operate on a basis whereby the competition within
that - as I say, that balance of openness and encouragement of people to
bring those resources and skills into the United Kingdom to deliver us the
requirement at best value for money. I
think the important thing, which I have not touched upon this morning, is that
we have shifted our emphasis in the Defence
Industrial Strategy to make value for money the bedrock of the whole thing
away from a particular technique, such as competition, to saying that
competition is one of the many tools which we will use and that is a
recognition of the realities of the different markets and environments we have
in the different sectors. For example,
take the C4-ISTAR type sector - very healthy, lots of innovation, does not
give you much intervention - and take another sector with much less
competition, which does have a key strategic defence capability for us, we need
to be much more clear about how much we manage that.

Q292 Robert Key: How
does that relate to investment decisions of private companies? We have just heard from BAE Systems on
explosives production, for example, that they do not believe they should be
investing in low technology, and so they are not very interested in the Royal
Ordnance factories at Bridgewater and Chorley, it seems. They do not mind if you cannot acquire ammunition
from the United Kingdom. Are you happy
with that? Does it fit in with your
analysis?

Lord
Drayson: I have looked at all of that very closely because it is very important
that the UK retains the ability, in terms of advance munitions like that, to be
able to source what it needs when it needs it, and I am satisfied that the
changes which are being made, which are about coming up with a more efficient
supply chain for the supply of these munitions by British Aerospace, does
satisfy our needs. The key thing there
is to be very clear in a manufacturing process, whether it is munitions or
anything else, of where the really clever bit is and making sure that we have
visibility of that clever bit, that we know where the skills are to do that,
and, where those skills are important to our defence capability, such as they
are in this particular case, that they are done in the United Kingdom. Do you want to add anything to that?

Mr Gould: Yes,
several things. Certainly on the
general munitions subject, it is difficult to distinguish between the raw
materials, which have always been bought in.
Even when things were being manufactured in Bridgewater and Chorley raw
materials were being brought in from outside, quite a lot of the supply chain
came from overseas. As I understand it,
if you have got a secure supply chain of raw materials, so long as you can
assemble and manufacture the munitions and have the capability to do that, then
you are in control of your own destiny.
That is the important point. I
would just like to pick up on one point.
Is there a premium for keeping things in the UK? I am not sure that there always is or has to
be. I was thinking in particular of
combat management systems in war ships and submarines. I cannot mention individual companies,
but some of the companies who work for us doing that are very competitive
internationally, and so, although we are keeping some of those skills in the
UK, and need to (this is very important), the fact that they are competitive
internationally tells me that maybe there is not a premium for that. Very often, if it is managed well, there
does not have to be a premium, but we do need to work very closely with the
companies to make sure that is the case.

Chairman: I will come back to you on that issue in just
a second. David Borrow, is there
anything you want to ask in relation to Bridgewater and Chorley or has the
subject been covered?

Q293 Mr Borrow: I
wanted to perhaps seek some more reassurance.
I am aware that the closure of Bridgewater and Chorley will lead BAE
Systems to purchase certain munitions from overseas, and they are currently
looking at a number of companies. I
have seen details of some of the companies overseas that they are looking to
buy from. There is an argument around
jobs, but there is a bigger issue around security of supply. Obviously, before we end UK production of
some of those munitions and rely on overseas suppliers, the MoD will need to be
absolutely certain that there is security of supply and that it is not possible
for another government, at a time when we are involved in military operations,
to stop us getting access to the munitions we need. I recognise that it is an issue around whereabouts in the
technology tree we should be putting investment, but, irrespective of that, and
that may be an issue for BAE Systems, as far as UK Plc and as far as UK
Military are concerned we need to be certain that we can get access to the
munitions that we need should we find ourselves in a situation of military
conflict in any part of the world. At
the moment those contracts have not been signed by BAE Systems, and I just want
some assurance that the MoD are going to be absolutely sure that there is absolute
certainty of security of supply before we allow those facilities at Bridgewater
and Chorley to disappear.

Lord
Drayson: That is absolutely central to our thinking. You are absolutely right.
The DIS sets out this point about defence needs coming first. We are very mindful of this point, and that
is what is guiding our thinking. We are
not able to go into the detail of this process, but you need to recognise that
there is a generational technology change taking place in these types of
munitions which is going to require us to go to the next generation of process
anyway. This is the opportunity to look
at this process and to look at how we can make it more efficient but also
making sure that we have got, as you say, absolute control over security of supply
for the United Kingdom. The way in
which this is being brought together, looking at the shift to manufacturing of
certain elements in Glasgow(?), is consistent with the objective of making sure
that we have maintained this capability.

Q294 Chairman: Can I double check something there. When Mike Turner was before us previously
and he was asked about the closure of factories at Bridgewater and Chorley, the
phrase he used was that they would want to be "fairly sure", but you would
accept the phrase that has just been used by David Borrow, "absolutely sure"
that we would have security of supply, would you?

Lord
Drayson: Yes, absolutely sure, and absolutely sure not just in terms of the
security of supply of the elements, as David has said. Often it is about the cleverness of the
process. What I think we need to be
absolutely sure about is what we do to the raw materials and how we bring these
things together and what is done here.
I want to be absolutely sure, in terms of security of supply of the
elements coming in and I also want to be absolutely sure about the robustness
of the manufacturing process that we are moving to, and I have spent quite a
lot of time checking that.

Q295 Mr Hancock: How
can you prevent that? How can you be
absolutely sure if, as we were told by the boss of the operation, they are
determined to close these plants? I am
interested to know how you can insist upon this and be assured that you are
going to get what you have asked for?

Lord
Drayson: We are the customer.

Q296 Mr Hancock: Whilst
the customer is always right, the customer does not always get what they
want. We have been in that situation as
a nation where we were dependent on certain elements of our weapons which were
not delivered, which we were restricted from using, and our soldiers were
seriously disadvantaged by it.

Lord
Drayson: That is absolutely right.

Q297 Mr Hancock: I am
interested to know how we can be absolutely sure of that now.

Lord
Drayson: We are learning the lessons of the past, and it is very important for
us as a nation to recognise that to get the defence capabilities we need in
many cases we have to enter into international collaborations, because the
nature of technology these days means you have to do that, but we also need to
be mindful of the point, which you rightly raise, of avoiding getting into a
position where in the future we are unable to use the defence equipment in the
way in which we wish to use it because of restrictions which are being placed
upon us, which is why we are thinking very intelligently, as set out in the
DIS, differentiating between the different types of equipment and capability
and making sure that we are taking decisions to deliver that defence
capability. This is an example where we
have got both a shift towards a different manufacturing process in a different
location and a shift in terms of procurement of certain elements in that and we
need to manage that very carefully indeed.
There is no easy answer to this.
The way in which you do it is by being very intelligent as a customer,
being robust in terms of what you expect your suppliers to do and making sure
that you have got these assurances in place and you check that they are in
place as you go forward.

Q298 Mr Borrow: I can
accept the situation that, if we were dealing with a small UK manufacturer of
munitions who had decided that it was not economic to continue to produce those
munitions, there is not a lot that the MoD can do, but in this situation we are
talking about a special arrangement and agreement between the MoD and BAE
Systems to supply the bulk of munitions.
That is part of the Defence
Industrial Strategy. They are in a
sense the preferred customer.
Therefore, if there are parts of that package of munitions which they
currently produce which as a company they decide it is not economic to produce
in the future, there is a strong obligation on them to satisfy the customer
that they can still supply those munitions, with an absolute guarantee of
supply, even if they as a company are not doing all the manufacturing. As I understand it, that is the key element
of the DIS in relation to explosives and munitions, the fact that BAE are
central to that role. Should they as a
company decide not to do certain things, they have still got the obligation to
deliver those munitions and explosives and guarantee absolutely that they will
be supplied as and when required by our military personnel.

Mr Gould: We
have had a partnering arrangement with Royal Ordnance for several years now in
response to the very incident that Mr Hancock referred to earlier with the
artillery ammunition. That has worked,
on the whole, pretty well for us.
Clearly, I could infer that it has not worked quite so well for the
company in some areas, but you are absolutely right: in seeking to have a negotiation
with a company that will continue that sort of long term arrangement, they
must, as part of that deal, satisfy us that the supply chain they are putting
in place does all the things that we require it to do. They must do it differently from the way it
has been done in the past but they must satisfy us or we do not do the deal, we
do something different. I am
optimistic.

Mr Hancock: You might be interested to know in the letter
that BAE Systems sent us today one of the companies that they put forward as
one of the five is in the very country that caused us all the problems last
time.

Q299 Robert Key: Hardly
a day goes by without somebody talking, either in the Houses of Parliament or
in the media, about the two-way street in defence procurement, particularly
with the United States of America. I
was delighted to see an interview with you at the time in February in which you
said that the battle over technology transfer was your top priority for this
year. How is it going, Minister?

Lord
Drayson: I would say it is progressing reasonably well, but the test will be
where we have got to at the end of this year, and the test will be the Joint
Strike Fighter. We are working very
hard indeed, I am working very hard indeed, on this issue because it is central
to our defence needs, and I know that the Secretary of State is also working
very hard, and throughout government.
JSF is a project where we recognise the real benefits which the
United Kingdom is gaining through working with the United States on this aircraft. However, we are also clear, as set out in
our Defence Industrial Strategy, that
being able to exercise the operational freedoms which we need over time with
this aircraft is affected by technology transfer. Therefore, the reason it is my top priority is because we know
that we need, by the end of this year, to have got clarity over certain
elements of technology transfer which need to happen (and I need to stress) on
a government to government basis to enable this to happen satisfactorily. I am optimistic that we can solve that. It is not a naive optimism, it is based upon
the progress which I think we are seeing, but we are working very hard on
it. I also think it indicates a general
shift which is taking place within the defence industry, and which you have
alluded to a bit already in your earlier question, which is the growing
strategic importance of intellectual property to defence capability. Therefore, what I am looking to see happen,
alongside the emphasis which we are placing on research and technology, is
strategic management of intellectual property in procurement decisions up front
in terms of clarity of the design authority, relationships with international
partners and technology transfer, and that is something which we are actively
working on this year, but I am expecting, frankly, for this to be resolved
satisfactorily for us by the end of this year.

Q300 Chairman: Research and technology. The Defence
Industrial Strategy accepts that more work needs to be done on this. What more work will be done and when will it
be done by?

Lord
Drayson: It will be done by the end of this year. The specific work which we are doing is to recognise that already
the UK spends a lot of money (2.3 billion a year) on defence research - we
are the second biggest spender on defence research - but we recognise that we
can improve the performance of the value which we get from the defence research
which we undertake and we will be publishing this year our Technology Strategy, which, as set out in the DIS, builds upon the
work which we have already done. That
is being led by Roy Anderson, the CSA within the MoD, and I think the important
thing with research is for us to recognise the real linkage between delivery of
defence capability and the research. We
need to improve the performance in bringing through the outputs of research to
making a difference to defence capability. In terms of my experience in managing research within industry,
the key thing is that you are really intelligent about the investments that you
make and you make sure that the innovation process is sufficiently fast moving
and entrepreneurial such that it does get through to make a real difference to
the front-line, to the defence capability, and we think there are some
improvements which we can make on that.
We are going to be publishing our Technology Strategy this year to
address these issues and to look at the balance of where we are making our
research spending. We are also opening
up more research spending to competition as a way of encouraging that process.

Q301 Chairman: All the witnesses we have had this morning
and earlier have talked about a decline in defence research and
technology. John Chisholm this morning
talked about a 50 per cent reduction and on page 39 of your Defence Industrial Strategy you talk
about the highly significant correlation between equipment capability and
R&T investment. What should the
Government be spending in research and technology?

Lord
Drayson: I like us to make decisions based upon data, and this study which you
allude to on page 39 was funded by the Ministry of Defence, carried out for us,
to really get a handle on how does research spend have an impact on defence
capability, and it is now clear for us.
What we have said in the DIS is that what we are going to be prioritising
this year is more emphasis on excellence.
What I learnt in terms of managing research is being very clear where
you do research which is really world-class.

Q302 Chairman: Can I bring you back to the decline that we
have had. Do you think we should have a
higher level of spending on defence and research?

Lord
Drayson: That is one of the things which we are going to be addressing this
year, and so I think we need to see the result of the Technology Strategy that
come out of it. What we see is that
there is a real correlation between how much we spend and the defence
capability which we get. I think there is
an important correlation also in terms of the effectiveness of what it is we
spend. My belief is, first, you fix
your effectiveness. Before you start
thinking about whether you are going to spend more money, you make sure that
the money you are spending you are spending wisely, and that is something we
are focused on as our number one priority.
Secondly, we need to look at the balance of the defence budget in terms
of investment on research and investment on equipment acquisition, and we need
to ask ourselves the question of whether we have got that right. Our current policy is that we will be
increasing our defence research spending in line with inflation. Up to now it has broadly been kept at the
same level. We have increased that by
saying that we are going to increase it in line with inflation. We need to look at whether we have got that
balance right. This year the emphasis
is on making sure that the way in which we spend the current research pounds is
as effective as we can make it, and that is the priority that the CSA has.

Q303 Mr Hancock: You talked about effectiveness. It
was suggested earlier that maybe one way of making the R&T spend
perhaps go further or be more effective is to integrate it into some form of
reinvention of demonstrator projects as part of the derisking activity of
overall projects. Is that part of the
thinking?

Lord
Drayson: Yes, that is part of it, making sure that we use opportunities to build
prototypes and we learn from doing that.
In certain areas the pace of change of technology and research is very
directly correlated to the military capability which we need right now. There is in some areas a real urgency. We are looking at areas to speed up this
process. Some really innovative things
have happened in the way in which we have restructured the defence research. The split of the Defence science and technology
laboratories with QinetiQ was a response to the increasing importance of
civilian research technologies into Defence.
That has really worked well. We
have now got a world-class business in QinetiQ. We have still got the DST labs doing the work which we need to do
on the most secret projects, but we are focused within the MoD on making sure
that there are not areas for us to go further in getting more bang out of the
money we spend on research today.

Mr Gould: I
wanted to say that the correlation as shown in the diagram is quite interesting
because it flattens out quite dramatically at the top. It is not a problem for us at the moment but
it does indicate that effectiveness really does matter in research, because you
can spend a lot on research and actually not get very much benefit at a later
stage. There are quite a few
demonstrator programmes that do still go on in the research programme related
to specific projects that are coming through in the future.

Q304 John Smith: What
about the development of centres of excellence in military research and
technology. Is there any early thinking
on that?

Lord
Drayson: They definitely work. That is a
model which has been used very successfully in the pharmaceutical
industry. Centres of excellence are
definitely working for us. It is an
example of a new approach to the management of R&D which is giving
benefits, but we cannot stop there.
There is more that we can do to improve the effectiveness of our
research and the speed at which it is brought through to deliver military
capability. That is the focus that we
have got.

Q305 Mr Hancock: I am
interested in the concept, which you emphasised quite a lot when you were last
giving evidence, of proper risk analysis going on and how that is going to be
funded. I sense that we will be
spending a lot more on that to get it right and not so much on the research and
development, because we are not developing new technology so much because you
are not going to be putting the money up front into it. We heard from John Chisholm today that he
expects you to be the main funders of that research. I was hoping he would say that the commercial world would be
inclined to invest more in the research side, but he declined that and felt it
was still the role of the MoD. Does it
not lead you then to look for off-the-shelf solutions from outside the UK
rather than to spend a lot of money on the risk evaluation of a product and a
lot of money on research and development; so you simply buy a tried and tested
product that might not have the full capability but is as near as you can get
to what you want?

Lord
Drayson: If the product which we want is available off the shelf, then we must
use it. I think that is the lowest risk
way of delivering the capability that we need.
We need to recognise that increasingly there is much more interplay
between defence research and civilian research than there ever was ten, 15
years ago, and we need to be more intelligent about exploiting that for our
benefit. An example of us doing that in
the DIS was our announcement about the UAV's project. There is an example, I think, where there is an absolute
overlap. There are going to be real
opportunities for unmanned vehicles in the civilian area and definitely for us
in the military area. We have given
clarity to industry of what our defence capabilities are, and we want to
encourage people to come into that, see that as a commercial opportunity, so
that young engineers, businessmen looking at start-ups say, "Right, there is a
real potential market opportunity here meeting the defence needs." It is about us then encouraging the way in
which that is done, and I have seen really good examples of entrepreneurial,
smart thinking in terms of research, particularly in response to the UAVs, and so
I think this is an area which we are building on quite effectively.

Mr Gibson: We
are actually increasing our funding of civil aerospace R&D. There was a report by the Aerospace
Innovation Growth Team in June 2003 which asked us to increase the level
of funding to 75 million a year, and we are largely achieving that and we
are doing it in a lot of innovative ways.
The Minister mentioned UAVs. We
are funding a UAV project on a commercial side, the DTI is putting in about
five million a year and the Regional Development Agencies are putting in about
11 million a year, matched in both cases by industry. We would be delighted if there were
spillovers from that civil project into the defence side. To the extent that we are increasing our
government funding on the civil side and that there are spillovers to defence,
we see as entirely positive.

Q306 Mr Hancock: I was
just going to ask a question on the performance measures you were going to
implement to judge how you were successful or otherwise on the DIS in both
organisations?

Lord
Drayson: From the MoD's point of view.

Q307 Mr Hancock: I know
what you said you wanted to achieve, Minister, but I would be interested to see
if the MoD had set themselves some targets for a change in their mentality?

Mr Gould: Our
ultimate measure will be our success in providing equipment capability into the
Armed Forces. If we see improvement in
the way in which projects are planned, conducted, executed and the speed with
which the capability is introduced into the system and then put on to the
battlefield and used, or hopefully not used, but used in a deterrent sense by
the Armed Forces, then that is the ultimate measure of success and every single
project that we undertake is measured in great detail in those terms.

Chairman: Moving on to partnering arrangements.

Q308 Mr Borrow: Fairly
briefly, because we have touched on the issue about partnering arrangements
earlier. One of the issues that has
been raised with us, and we have had evidence in previous hearing about it, is
a suggestion that because BAE Systems, in particular, have such a dominant role
in the partnership arrangements under the DIS there is a risk that they could
become a monopoly supplier. Would that
be in the long-term interests of the MoD or are there are dangers in that in
terms of getting value for money in view of the lack of competition in that
area? I understand the dilemma, but can
you explore that a little bit?

Lord
Drayson: I think, first of all, that it is excellent
that we have in BAE a global player within the defence industry, one that really
can go toe to toe against the best in the world and win. That is very importantly positive for the UK
defence interest. Secondly, I think we
need to look at the data. The reality
is that five per cent of the MoD's defence contracts per year go to BAE. That is the fact.

Q309 John Smith: Is that by value?

Lord
Drayson: Yes, by value. Direct defence
contracts to BAE from the MoD, if you look at the last two years, five per
cent. If you look at BAE's customers,
the MoD represents 28 per cent of their turnover. I recognise people's concern about this, but I would say the boot
is on the other foot a bit. We are a
very important customer to BAE, but we need to recognise that in a number of
important areas for us BAE is the design authority - if you look at the
number of our armoured vehicles, for example - and, therefore, what the
DIS does is face up to the reality, which is that we are in a mutual dependence
with BAE in some very important areas for us and we need to manage that with
the appropriate management tools to get value for money for the British
taxpayer. It is about tough partnership. It is about BAE delivering improved
performance in return for longer term business with us. I think that the way in which we are moving
with BAE is very positive for the British interest and the defence taxpayer
value for money point of view.

Q310 John Smith: But
how, Minister, do you incentivise a sole monopoly supplier to maintain best
practice and continue to be efficient if there is no alternative capability in
the long-term? How do you do it?

Lord
Drayson: Firstly, you only enter into those types of arrangements if those are
the realities of the market you are operating in. If you have got a market which allows you to have a competition,
then competition is the right tool. In
certain circumstances where you do have de facto a monopoly supplier,
you need to manage it to respond to that.
The way in which you do that is to enter into longer term contracts
where the payments to the company are linked to improvements in
performance. What you do is make a
direct correlation between their profit and their improved performance over
time through a sustained relationship and you make the metrics of the
relationship really clear. You build
the contract around that. What you have
to have within the MoD are people with the skills to be able to write and
manage those types of long-term relationships.
I know from my own personal experience industry is used to these types
of relationship. For example, many
companies partner their IT systems because they recognise they are not the
world's experts in IT, and they enter into a recognition of long-term
relationships with companies to do that.
For the MoD to make a success, we need to get really competent and
professional, actually excellent, in the way in which we manage these types of
long-term partnerships. An important
pilot for us, if you like, the first one we are doing, is with Augusta Westland
on certain types of helicopter. That is
another example of where we have this de facto relationship on a whole
fleet of helicopters which we are already using. It is very important for us to manage that long-term relationship
with Augusta Westland on the maintenance and sustainment of that fleet.

Q311 John Smith: A
leading defence industrialist earlier today told us that he thought competition
had been a disaster for the UK defence industry. Do you share that view?

Lord
Drayson: No, I do not think it has been a disaster. The way I look upon it is that the defence industry is not
homogenous. The different sectors
within the defence industry exhibit very different market characteristics. Therefore the MoD needs to be sophisticated. It needs to use competition, where
competition is the right tool, to get the best value for money for the taxpayer
and, where competition is not the right tool (and we have seen some instances
where it has been used in a way which has not produced a good outcome), that we
do not use it. For example, on Carrier,
because we need a number of different companies coming together to build these
enormous carriers we needed to form an alliance, and we need to make sure that
the way in which that alliance is formed fits the realities of the market. I do not think it has been a disaster but I
think we have got more intelligent at picking up the right tool for the job and
using it in the particular circumstances of the particular project in the
particular sector.

Q312 Robert Key: How does the Government see the European Defence Agency developing?

Lord
Drayson: It should learn to walk before it runs. It needs to show that it can really add value. We think that there are some ways in which
it is beginning to show that, but our view is that it should start small, have
some successes and then grow.

Q313 Robert Key: Are
there other implications for the wider international defence industry here that
you can have? We have been told by some
of our witnesses, for example, that they feel not enough attention has been
given to the international dimension of the Defence
Industrial Strategy?

Lord
Drayson: The feedback that I have had from our international partners has been
very positive about that. They have
found it useful to have clarity, whether it is in the direction of the United
States or the direction of Europe. One
positive example of the EDA is the way in which the code of conduct has been
established for other nations, which is aiming to encourage other nations to be
as open as we are in some of their defence procurements. We have set out principles pretty clearly in
the DIS as to the way in which we want to do business with our international
partners - clarity and sovereignty, and so forth. We think that is a positive start.

Q314 Mr Havard: We
did have some questions, one of which is a bit mischievous, about how you might
get more money from the Treasury, but if you can spend the money you have got
more effectively that is a good start.
I was interested in what you have said about how you are going to deal
with these things. Quite clearly the
Strategy as we have it is the overview.
There are clearly a number of strategies within different working groups
and different things that you have spoken about already. You have talked about the technology review
coming towards the end of the year. I
think you have talked about some work being done about process that might
report in June. I cannot remember
whether you have set a date for the Maritime Industrial Strategy, and so
on. Can you give us an idea, because
you have been described by some as having gone through the model like a whirlwind
so far - that is what has been said about you.
What is the pace at which we are going to see these sector analyses and
programmes so that we can have an idea of what is coming when and how we can
also judge what we need to do in terms of how we can continue to scrutinise the
process?

Lord
Drayson: I have two sides of A4, Mr Havard, which is my check-list of the to-do
list of things which we had promised within the DIS would be achieved, and I am
very happy to be held accountable for us achieving those. We have identified within the Ministry of
Defence specific people with accountability for delivering them to me. I have set out a ministerial direction to the
MoD that decisions must be taken consistent with the DIS, and if we are looking
at taking a decision which is not consistent with the DIS, I want to know about
it. I think that we have set out our
target dates - we mention May - for having clarity about the changes that we
need to make in terms of our acquisition processes, we have set about a
technology strategy which we are doing this year, I want to see the maritime
industrial strategies implemented in 2006.
It is very important for some of the big projects which we have got. We have got a clear to-do list which I am
monitoring very closely indeed.

Chairman: Two sides of A4. We like that.

Q315 Mr Havard: Is it
possible we could have visibility of this?

Lord
Drayson: You are very welcome to have both sides.

Q316 Mr Havard: It is quite clear you have got a momentum,
and the tempo is important in terms of war fighting and in terms of rugby and
so I am looking to learn lessons for other purposes!

Lord
Drayson: I would be happy, Chairman, to share the list.

Chairman: Thank you very much. That would be extremely helpful. You have come in before one o'clock, which
is another significant achievement.
Thank you very much indeed, to all three of you, for your evidence and
to the Committee for your questions.